[House Hearing, 108 Congress]
[From the U.S. Government Publishing Office]




          EXPANDING COVERAGE OF PRESCRIPTION DRUGS IN MEDICARE

=======================================================================

                                HEARING

                               before the

                      COMMITTEE ON WAYS AND MEANS
                     U.S. HOUSE OF REPRESENTATIVES

                      ONE HUNDRED EIGHTH CONGRESS

                             FIRST SESSION

                               __________

                             APRIL 9, 2003

                               __________

                            Serial No. 108-7

                               __________

         Printed for the use of the Committee on Ways and Means


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                            WASHINGTON : 2003
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                      COMMITTEE ON WAYS AND MEANS

                   BILL THOMAS, California, Chairman

PHILIP M. CRANE, Illinois            CHARLES B. RANGEL, New York
E. CLAY SHAW, JR., Florida           FORTNEY PETE STARK, California
NANCY L. JOHNSON, Connecticut        ROBERT T. MATSUI, California
AMO HOUGHTON, New York               SANDER M. LEVIN, Michigan
WALLY HERGER, California             BENJAMIN L. CARDIN, Maryland
JIM MCCRERY, Louisiana               JIM MCDERMOTT, Washington
DAVE CAMP, Michigan                  GERALD D. KLECZKA, Wisconsin
JIM RAMSTAD, Minnesota               JOHN LEWIS, Georgia
JIM NUSSLE, Iowa                     RICHARD E. NEAL, Massachusetts
SAM JOHNSON, Texas                   MICHAEL R. MCNULTY, New York
JENNIFER DUNN, Washington            WILLIAM J. JEFFERSON, Louisiana
MAC COLLINS, Georgia                 JOHN S. TANNER, Tennessee
ROB PORTMAN, Ohio                    XAVIER BECERRA, California
PHIL ENGLISH, Pennsylvania           LLOYD DOGGETT, Texas
J.D. HAYWORTH, Arizona               EARL POMEROY, North Dakota
JERRY WELLER, Illinois               MAX SANDLIN, Texas
KENNY C. HULSHOF, Missouri           STEPHANIE TUBBS JONES, Ohio
SCOTT MCINNIS, Colorado
RON LEWIS, Kentucky
MARK FOLEY, Florida
KEVIN BRADY, Texas
PAUL RYAN, Wisconsin
ERIC CANTOR, Virginia

                    Allison H. Giles, Chief of Staff

                  Janice Mays, Minority Chief Counsel


Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public 
hearing records of the Committee on Ways and Means are also published 
in electronic form. The printed hearing record remains the official 
version. Because electronic submissions are used to prepare both 
printed and electronic versions of the hearing record, the process of 
converting between various electronic formats may introduce 
unintentional errors or omissions. Such occurrences are inherent in the 
current publication process and should diminish as the process is 
further refined.


                            C O N T E N T S

                               __________

                                                                   Page
Advisories announcing the hearing................................     2

                               WITNESSES

Congressional Budget Office, Douglas Holtz-Eakin, Ph.D., Director     9
U.S. General Accounting Office, Hon. David M. Walker, Comptroller 
  General........................................................    21

                                 ______

Pauly, Mark V., University of Pennsylvania.......................    82
Reinhardt, Uwe E., Princeton University..........................    88
Stuart, Bruce, University of Maryland School of Pharmacy.........    78

                       SUBMISSIONS FOR THE RECORD

American Academy of Actuaries, Cori E. Uccello and John M. 
  Bertko, statement..............................................   110
American Health Quality Association, David G. Shulke, statement..   115
Long Term Care Pharmacy Alliance, John F. Jonas, letter..........   118
National Association of Chain Drug Stores, Alexandria, VA, 
  statement......................................................   119

 
          EXPANDING COVERAGE OF PRESCRIPTION DRUGS IN MEDICARE

                              ----------                              


                        WEDNESDAY, APRIL 9, 2003

                     U.S. House of Representatives,
                               Committee on Ways and Means,
                                                    Washington, DC.

    The Committee met, pursuant to notice, at 11:10 a.m., in 
room 1100 Longworth House Office Building, Hon. Bill Thomas 
(Chairman of the Committee) presiding.
    [The advisory and revised advisory announcing the hearing 
follow:]

ADVISORY FROM THE COMMITTEE ON WAYS AND MEANS

                                                CONTACT: (202) 225-1721
FOR IMMEDIATE RELEASE
April 2, 2003
No. FC-7

                 Thomas Announces Hearing on Expanding

               Coverage of Prescription Drugs in Medicare

    Congressman Bill Thomas (R-CA), Chairman of the Committee on Ways 
and Means, today announced that the Committee will hold a hearing on 
modernizing Medicare and integrating prescription drugs into the 
program. The hearing will take place on Wednesday, April 9, 2003, in 
the main Committee hearing room, 1100 Longworth House Office Building, 
beginning at 10:30 a.m.
      
    In view of the limited time available to hear witnesses, oral 
testimony at this hearing will be from invited witnesses only. Invited 
witnesses will include Dr. Douglas Holtz-Eakin, Director, Congressional 
Budget Office, and academics with extensive knowledge of prescription 
drugs and the Medicare program. Also, any individual or organization 
not scheduled for an oral appearance may submit a written statement for 
consideration by the Committee or for inclusion in the printed record 
of the hearing.
      

BACKGROUND:

      
    When Medicare was enacted in 1965, most health insurers did not 
cover prescription drugs. Since that time, most private health plans 
have fully integrated prescription drug coverage yet Medicare still 
does not cover most outpatient prescription drugs. Prescription drugs 
are now as important to health care as hospitals and physician services 
were 38 years ago.
      
    Seniors are more likely to be faced with high out-of-pocket 
prescription drug costs than other individuals. While seniors comprise 
approximately 12 percent of the population, they consume nearly 40 
percent of all prescription drugs. Yet nearly one-third of Medicare 
beneficiaries do not have some type of prescription drug coverage, and 
those without coverage often pay the highest prices for their 
medications. Further, many employers through their company retirement 
benefit plans are paring back or dropping prescription drug coverage as 
costs continue to dramatically escalate. Medigap plans with drug 
coverage are becoming increasingly unaffordable. Prescription drug 
costs are rising annually at double-digit rates. This causes seniors 
without coverage to often forgo necessary prescriptions, while 
jeopardizing current prescription drug coverage.
      
    At the same time, Medicare's current costs are dramatically rising. 
For example, according to the Center for Medicare and Medicaid 
Services' Office of the Actuary, hospital costs were up by 10 percent 
last year. Likewise, skilled nursing home expenditures rose by 9 
percent, home health spending increased by 14 percent, durable medical 
equipment spending increased by 20 percent, and hospice expenditures 
rose by 24 percent. These increased expenditures are partially borne by 
beneficiaries, whose Part B premiums are projected to rise by 12.4 
percent next year.
      
    Escalating Medicare spending in all areas means a new Medicare 
prescription benefit must be carefully designed to be affordable to 
both beneficiaries and taxpayers. In fact, all aspects of the program 
must be examined to discern where inefficiencies exist and changes need 
to be made.
      
    In the last Congress, the House passed a Medicare prescription drug 
bill (H.R. 4954), but the Senate failed to act on the legislation. The 
President included $400 billion over 10 years in the fiscal year 2004 
budget. The House and Senate passed resolutions to include the same 
amount for prescription drugs, Medicare modernization, and appropriate 
adjustments to provider payments.
      
    In announcing the hearing, Chairman Thomas stated, ``The House 
passed Medicare modernization and prescription drug legislation in the 
106th and 107th Congresses. It is clear that this Congress must make 
law.''
      

FOCUS OF THE HEARING:

      
    This hearing will focus on issues related to an outpatient 
prescription drug benefit for Medicare beneficiaries.
      

DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:

      
    Please Note: Due to the change in House mail policy, any person or 
organization wishing to submit a written statement for the printed 
record of the hearing should send it electronically to 
[email protected], along with a fax copy to 
(202) 225-2610, by the close of business, Wednesday, April 23, 2003. 
Those filing written statements that wish to have their statements 
distributed to the press and interested public at the hearing should 
deliver their 200 copies to the full Committee in room 1102 Longworth 
House Office Building, in an open and searchable package 48 hours 
before the hearing. The U.S. Capitol Police will refuse sealed-packaged 
deliveries to all House Office Buildings.
      

FORMATTING REQUIREMENTS:

      
    Each statement presented for printing to the Committee by a 
witness, any written statement or exhibit submitted for the printed 
record or any written comments in response to a request for written 
comments must conform to the guidelines listed below. Any statement or 
exhibit not in compliance with these guidelines will not be printed, 
but will be maintained in the Committee files for review and use by the 
Committee.
      
    1. Due to the change in House mail policy, all statements and any 
accompanying exhibits for printing must be submitted electronically to 
[email protected], along with a fax copy to 
(202) 225-2610, in Word Perfect or MS Word format and MUST NOT exceed a 
total of 10 pages including attachments. Witnesses are advised that the 
Committee will rely on electronic submissions for printing the official 
hearing record.
      
    2. Copies of whole documents submitted as exhibit material will not 
be accepted for printing. Instead, exhibit material should be 
referenced and quoted or paraphrased. All exhibit material not meeting 
these specifications will be maintained in the Committee files for 
review and use by the Committee.
      
    3. Any statements must include a list of all clients, persons, or 
organizations on whose behalf the witness appears. A supplemental sheet 
must accompany each statement listing the name, company, address, 
telephone and fax numbers of each witness.
      
    Note: All Committee advisories and news releases are available on 
the World Wide Web at http://waysandmeans.house.gov.
      
    The Committee seeks to make its facilities accessible to persons 
with disabilities. If you are in need of special accommodations, please 
call 202-225-1721 or 202-226-3411 TTD/TTY in advance of the event (four 
business days notice is requested). Questions with regard to special 
accommodation needs in general (including availability of Committee 
materials in alternative formats) may be directed to the Committee as 
noted above.
                                 

                   * * * NOTICE--CHANGE IN TIME * * *

ADVISORY

FROM THE 
COMMITTEE
 ON WAYS 
AND 
MEANS

                                                CONTACT: (202) 225-3943
FOR IMMEDIATE RELEASE
April 4, 2003
No. FC-7-REV

                Change in Time for Hearing on Expanding

               Coverage of Prescription Drugs in Medicare

    Congressman Bill Thomas (R-CA), Chairman, Committee on Ways and 
Means, today announced that the Committee hearing on modernizing 
Medicare and integrating prescription drugs into the program scheduled 
for Wednesday, April 9, 2003, at 10:30 a.m., in the main Committee 
hearing room, 1100 Longworth House Office Building, will now be held at 
11:00 a.m.
      
    All other details for the hearing remain the same. (See full 
Committee Advisory
No. FC-7 dated April 2, 2003.)

                                 

    Chairman THOMAS. The Chair considers this one of the more 
important hearings the full Committee will have as we consider 
how to modernize Medicare and, obviously, the importance of 
Medicare and the improvements it has made in millions of 
seniors' lives, especially as we notice that seniors are living 
longer and actually healthier lives than any generation in 
history. Although one of the reasons we are holding the hearing 
is because we think Medicare can do better. It really isn't 
21st century-ready; it isn't even the last quarter of the 20th 
century-ready, because it doesn't provide a meaningful 
prescription drug coverage to seniors, who, coincidentally, are 
the largest group of consumers of the pharmaceuticals. In 
modern health care, prescription drugs are often the health 
care solution of choice. They prevent, treat, or manage 
diseases more effectively and less invasively than hospitals.
    However, as we all know, Medicare provides extremely 
limited coverage for what are today vital medicines. That means 
the typical senior will spend about $1,450 out of pocket on 
prescription drugs this year. Unfortunately, notwithstanding 
that amount, seniors often pay the highest price because about 
a third of the seniors have no prescription drug coverage. 
However, as we all know, Medicare provides extremely limited 
coverage for what are today vital medicines. That means the 
typical senior will spend about $1,450 out of pocket on 
prescription drugs this year. Unfortunately, notwithstanding 
that amount, seniors often pay the highest price because about 
a third of the seniors have no prescription drug coverage.
    Clearly something has to be done. Change cannot occur in a 
vacuum. You have to consider the context. This March, the 
Medicare trustees issued their annual report, which said that 
Medicare will start running deficits in about 10 years, and 
will go broke in 2026. This is complicated by the Congressional 
Budget Office's (CBO) projection that annual spending on 
Medicare will more than double over the next 10 years, while 
spending on prescription drugs will triple.
    Analysis by the Centers for Medicare & Medicaid Services 
(CMS) Actuary also shows that Medicare spending last year 
spiked. Hospital spending was up 10 percent; home health up 14 
percent; skilled nursing facilities up 9 percent; durable 
medical equipment up 20 percent. All of these increases 
occurred with the backdrop of inflation at about 2.4 percent.
    Integrating a prescription drug benefit to Medicare will 
clearly improve seniors' health and is long overdue. Hopefully, 
it can also reduce what would otherwise be Medicare's cost over 
time because we can substitute drugs as a more effective and 
less expensive alternative than some other treatment options. 
Also hopefully, we can integrate drugs around a disease 
management program that would provide a more comprehensive 
package for seniors when they are on multiple drugs, which is 
becoming more the pattern than not.
    Steps must be taken when crafting the prescription drug 
benefit into other changes to ensure the sustainability of 
Medicare over the long haul. To simply take current Medicare 
and add prescription drugs is not the solution. The Medicare 
Payment Advisory Commission (MEDPAC), the non-partisan panel of 
experts that advise this Congress, has made a number of 
recommendations which would slow the growth of Medicare and 
which this Committee will examine very carefully.
    History, and especially recent history, shows that we can 
deliver. In the last two Congresses, this Committee has 
produced, and the House has approved, legislation to modernize 
Medicare. As we know, those bills did not become law. They did 
not become law with a Democratic Senate and they did not become 
law with a Republican Senate. This year, the President has 
indicated he is willing to provide an additional $400 billion 
over 10 years to improve Medicare. The House and the Senate has 
passed a budget agreeing that that money would be utilized for 
Medicare.
    We should not squander this opportunity to deliver 
prescription drugs for seniors while improving and 
strengthening Medicare for future generations. Shortly we will 
hear from the Director of the Congressional Budget Office, Dr. 
Douglas Holtz-Eakin, who I believe is in his first appearance 
in front of the Committee on Ways and Means, and David Walter, 
the Comptroller General of the General Accounting Office, who 
has been before us previously and who plays a significant role 
both in producing documents that assist us in making decisions 
and in making sure that those institutions which advise us are 
professionally structured and maintained.
    Prior to doing that, I will recognize the Ranking Member 
from New York, Mr. Rangel, for any comments he would like to 
make.
    [The opening statement of Chairman Thomas follows:]

    Opening Statement of The Honorable Bill Thomas, Chairman, and a 
        Representative in Congress from the State of California

    As the Committee considers how to modernize Medicare, it's worth 
noting that since its inception Medicare has improved the lives of 
millions of our nation's seniors. Today, our seniors are living longer 
and healthier lives than any generation in history.
    But we can do better. Medicare is not 21st century-ready. It does 
not provide prescription drug coverage to seniors--the largest 
consumers of pharmaceuticals.
    In modern health care, prescription drugs are often the health care 
solution of choice. They prevent, treat or manage diseases more 
effectively and less invasively than hospitals.
    However, Medicare provides extremely limited coverage for what are 
today vital medicines. That means the typical senior will spend about 
$1,450 out of pocket on prescription drugs this year. And unfortunately 
seniors often pay the highest prices because more than one-third of 
seniors have no prescription drug coverage.
    But change can't occur in a vacuum; we must first consider the 
context. This March, the Medicare Trustees issued their annual report 
which said that Medicare will start running deficits in about ten years 
and will go broke in 2026. This is complicated by the Congressional 
Budget Office's projection that annual spending on Medicare will more 
than double over the next ten years, while spending on prescription 
drugs will triple.
    Analysis by the Centers for Medicare and Medicaid Services Actuary 
also shows that Medicare spending last year spiked: hospital spending 
was up ten percent, home health up 14 percent, skilled nursing 
facilities up nine percent and durable medical equipment up 20 percent. 
And all of these increases occurred with a backdrop of inflation around 
2.4 percent.
    Integrating a prescription drug benefit to Medicare will clearly 
improve seniors' health and is long overdue. Hopefully it can also help 
reduce Medicare's costs over time because we can substitute drugs as a 
more effective and less expensive alternative to other treatment 
options. Integrating prescription drugs around disease management is 
important for seniors when they take multiple prescription drugs, which 
is happening more and more.
    Steps must be taken when crafting the prescription benefit and 
other changes to ensure the sustainability of Medicare over the long 
haul. To take the current Medicare system and simply add on 
prescription drugs is not a solution. The Medicare Payment Advisory 
Commission, the non-partisan panel of experts that advises Congress, 
has made a number of recommendations to slow the growth of Medicare, 
which this Committee will examine very carefully.
    History shows we can deliver. In the last two Congresses, this 
Committee has produced and the House has approved legislation to 
modernize Medicare. As we know, those bills did not become law. This 
year, the President recommended an additional $400 billion over ten 
years to improve Medicare. The House and Senate have passed budget 
resolutions providing for these resources. We should not squander this 
opportunity to deliver prescription drugs for seniors while improving 
and strengthening Medicare for future generations.

                                 

    Mr. RANGEL. Thank you, Mr. Chairman, and thank you for 
bringing the Committee together on this most important subject 
matter. It has been almost a year since when we last visited 
it. I agree with you that this serious national issue demands 
and screams for some type of relief and solution, and everybody 
who campaigned, campaigned that they would do that. I do hope 
that you would agree, however, that this matter, there is no 
Democrat or Republican or presidential solution, that we should 
be working together. I understand that we have not been doing 
that. We have no bill, we have no direction.
    We welcome a hearing from the witnesses, and I would like 
to yield to the Ranking Member on the Subcommittee on Health so 
that he can share with us what progress has been made by the 
Committee on this important subject. Mr. Stark.
    Mr. STARK. Well, thank you, Mr. Rangel.
    Mr. Chairman, thank you for holding this hearing. I notice 
from the comments today in the Congress Daily, that this 
hearing is to be the launch pad for getting started on a 
Medicare prescription drug benefit, that your approach will be 
comprehensive, dealing with Medicare as a whole and not just as 
a prescription drug benefit. I am hopeful that this morning we 
will hear more about what you really mean. The answer to that 
question outlines, I think, the entire debate.
    Are we going to move ahead to add a prescription drug 
benefit in Medicare in order to improve the Medicare program 
for seniors and people with disabilities, or will we use the 
allure of a prescription drug benefit as a tool to achieve 
fundamental restructuring--I would call it dismantling--of the 
Medicare program? Will the addition of long-overdue drug 
benefits come at the cost of ending Medicare as we know it, as 
an entitlement program that guarantees all seniors and people 
with disabilities access to the same set of benefits for the 
same costs? These are the questions that need to be answered.
    I note that this hearing has no witness from the 
Administration. I would comment that the Energy and Commerce 
hearing yesterday, another hearing today, and a Joint Economic 
Committee hearing scheduled for tomorrow--no Administration 
witnesses. Now, I don't know if that is because they have 
refused to come, or they have not been invited. It leaves us 
all wondering what direction you plan to go, Mr. Chairman, with 
the Medicare prescription drug benefit. Are you going to 
proceed with a plan that is similar to that passed last year in 
the House, or will you take into account the policy the 
President has put forth? I think the American public, and 
especially America's seniors, would like to see that answered. 
Certainly, we on our side of the aisle would be better able to 
proceed in a bipartisan manner if we had some indication of 
what you had in mind.
    Finally, I hope this is not the only hearing that we have 
prior to moving a Medicare bill through our Committee onto the 
House floor. Having a bill completed, as I know you want to, by 
the end of May is an ambitious agenda when the American public 
has never seen or been able to have any input in what you may 
plan to do. This is a program that covers 40 million lives and 
will cover many more than that before long. Change to this 
needs to be made in the open, and the seniors need to know what 
your plan will really mean for them.
    So, once your plan is announced, I hope we will have more 
hearings that will allow representatives of the seniors 
organizations and others affected by the changes to come before 
our Committee and provide their counsel to this major change.
    I look forward to hearing from the witnesses today and want 
to especially welcome Professor Uwe Reinhardt, who has come to 
share with us a bit of wisdom with regard to the Medicare 
reform. I thank the Chair again.
    Chairman THOMAS. Thank the gentlemen. The Ranking Member of 
the Subcommittee on Health posed a number of questions, and to 
make sure that people don't think they were rhetorical, the 
Chair will respond briefly prior to recognizing the first 
panel.
    The Ranking Member from New York indicated that all Members 
had taken a position on this issue during campaigns--therefore 
setting a clear political tone--but then indicated there were 
Democrat or Republican solutions. The Chair finds it 
interesting, then, that the Ranking Member of the Subcommittee, 
from California, indicated that before they could proceed in a 
bipartisan manner, they needed the majority to commit to a 
partisan position so they could therefore react in a bipartisan 
way.
    I tell the gentlemen that, just as in the last two 
Congresses, the plan that passes this Committee and will pass 
the House will be a Medicare plan under Medicare. The attempt 
to characterize the plans that have been passed as not under 
Medicare may in fact revert back to that campaign position that 
the gentleman from New York referred to. No plan has been 
offered and no plan has passed that does not come under 
Medicare. It is not outside of Medicare, it isn't a 
privatization; it is a Medicare program.
    The reason we are holding a hearing is to try to ask basic 
questions, not to flak for any particular plan on either side 
of this dais. It is to inquire about the best estimate of cost 
of proposals that have been presented in the past, as a guide 
to helping us make decisions in the future. I think the panel 
will provide us with some basic understandings, so that as we 
begin to examine bills we have more of a common knowledge base 
in which to address the options that might be presented to us. 
The Chair believes that is the best way to pursue a program 
that has the best chance of not bankrupting Medicare, but 
providing prescription drugs for seniors.
    With that, the Chair is once again pleased to recognize Dr. 
Holtz-Eakin, who is the new head of Congressional Budget 
Office, been in place for just a few months. I am sure that you 
have already fully appreciated the stress and cross-purposes 
for which that position was delightfully created. I am always 
amazed that people with brilliant academic backgrounds and 
successful work experience say yes to putting themselves in the 
kind of position that the Director of the Congressional Budget 
Office finds himself shortly after saying yes.
    Also, to David Walker, who has a very difficult job in 
which Members ask the General Accounting Office to produce any 
number of documents, which are done in a timely fashion and in 
a scholarly way. If they don't conform to preconceived notions 
of what the report should have been, they aren't given the 
credence they should be. I have been pleased to say that, 
notwithstanding where the outcome of the research might fall, 
that the research itself has been impeccable. For that, I do 
want to compliment Mr. Walker. He, for this Committee, performs 
another service, and that is tends to oversee, as the landlord, 
the MEDPAC Commission, which is critical to assisting us in 
evaluating what is going on in the medical world so that we can 
make very difficult decisions across the broad spectrum of 
providers.
    With that----
    Mr. RANGEL. Mr. Chairman, would you yield----
    Chairman THOMAS. Certainly.
    Mr. RANGEL. For purposes of allowing me to join in 
welcoming our new Director. He brings a lot of credibility and 
prestige to this most important job. We look forward to working 
with you in a bipartisan way. Of course, I have always been a 
great supporter of U.S. General Accounting Office (GAO) and the 
great work that you do for the Congress and the country. We 
look forward to working with you. Thank you, Mr. Chairman.
    Chairman THOMAS. Thank the gentleman very much for his 
comments.
    Any written presentation you may have, gentlemen, will be 
made a part of the record, and you can address us in any way 
that you see fit in the time that you have available to you. 
These microphones are fifties era. The Chair hopes we will 
remodel this room soon. It has great ambiance, but we also need 
decent acoustics. So, if you will address directly into the 
mike, Members and the audience will have a chance to hear you. 
Dr. Holtz-Eakin.
    [The opening statement of Mr. Ramstad follows:]

  Opening Statement of The Honorable Jim Ramstad, a Representative in 
                  Congress from the State of Minnesota

    Mr. Chairman, thank you for calling this important hearing on the 
critical issue of providing America's seniors with prescription drug 
coverage and Medicare's fiscal challenges.
    As founder and co-chair of the House Medical Technology Caucus, I 
appreciate the incredible advances that medical technology and 
pharmaceuticals have made in recent years to treat and cure 
debilitating conditions. These advances are truly breathtaking and will 
become more and more prevalent as medical science continues to advance.
    Unfortunately, the Medicare system penalizes seniors by 
incorporating these advances too late, if at all.
    Congress needs to comprehensively reform Medicare to modernize the 
program and expand access to critical new technologies and drugs. By 
acting this year, we can improve health, save lives and save the system 
money.
    The question is how to maintain the standard of care enjoyed by 
America's seniors, improve the system and meet the incredible 
demographic challenges facing us. This is not a simple task, and a 
prescription drug benefit will place new pressure on Medicare as our 
nation's senior population grows.
    With the President and Congress committing to invest $400 billion 
over the next ten years on Medicare reform and a prescription drug 
benefit, the time to act is now. Our seniors have waited too long.
    At the same time, we must ensure the long-term stability of the 
Medicare system so that it is vibrant for both current and future 
beneficiaries. To that end, we must examine the fiscal implications of 
our actions, and examine ways to prevent wasteful spending while 
ensuring the highest quality of care for our seniors.
    Thank you again, Mr. Chairman, for holding this important hearing.

                                 

      STATEMENT OF DOUGLAS HOLTZ-EAKIN, PH.D., DIRECTOR, 
                  CONGRESSIONAL BUDGET OFFICE

    Dr. HOLTZ-EAKIN. Well, thank you, Mr. Chairman, thank you, 
Mr. Rangel, both, for the chance to be here and for the 
gracious welcome. I really do appreciate it and look forward to 
working with you.
    You have my written testimony. Let me take my time and pull 
out what I think are key facts that may be of some use to the 
Committee in thinking about the issues that face us today.
    One message that I hope comes through clearly is that the 
entitlement programs of Medicare, Medicaid, and Social 
Security, as currently structured, are on a trajectory to 
overwhelm the Federal budget. Currently, these three programs 
constitute 8 percent of gross domestic product (GDP). By the 
year 2030, they will rise to 14 percent of GDP--a bit under the 
size of the Federal budget at the moment; and by the year 2075, 
they will rise to fully 21 percent of GDP, a share larger than 
that of the Federal budget.
    Medicare is the largest part of that rise. The chart that 
we have pulled out of the testimony to display shows this rapid 
rise in Medicare as a fraction of GDP from 2.4 percent today to 
about 9.2 percent in 2075. As you can see on the chart, that 
rise comes in two different components. The first is a 
component that just is due to the aging-of-the-population 
phenomenon, with which you are quite familiar. That is a 
smaller component, about 30 percent of the overall increase. 
The larger component comes from the rapid rise in health care 
costs above the growth in GDP. That excess cost growth is not 
unique to Medicare, but is at the source of the large run-up in 
this entitlement program as a fraction of GDP.
    Now, if we turn to cost growth in Medicare per se, CBO 
projects that over the next 10 years in the budget window, 
Medicare will continue to grow faster than GDP, at about 6.8 
percent per year. As we detailed in the testimony, there are 
limited direct tools at the Congress' disposal to control that 
growth. It is a phenomenon that exists not only in Medicare, 
but in the health care area as a whole.
    Now, for the purpose of this hearing, an interesting piece 
of information is the growth in prescription drug spending. On 
that front, there is both good news and bad news. CBO's 
baseline projections for prescription drug spending by the 
Medicare population indicate that the good news is that 
spending in the baseline is up by only 4 percent from last 
year. Typically, one might expect a larger increase in baseline 
spending. The 4-percent increase comes from the net effect of 
dropping a relatively inexpensive year at the beginning of the 
budget window and adding a relatively expensive year at the end 
of the budget window--that is the typical story. This year, we 
also learned, after looking into the research, that we had less 
underreporting of prescription drug spending than had 
previously been thought and slower growth in prescription drug 
prices than had been anticipated.
    The net effect of that is a modest increase in our baseline 
estimates of prescription drug spending by this population, 
making it easier to compare cost proposals. Although they won't 
all be 4 percent higher--it depends on the details of the 
proposals--it does make year-to-year comparisons a bit easier, 
perhaps, than in the past.
    Now, the bad news is that prescription drug spending 
continues to rise faster even than overall Medicare spending 
itself. We project that over the 10-year budget horizon, it 
will rise by 9 percent per year, for a total of $1.8 trillion.
    The final piece that I would like to pull out of the 
testimony is the composition of some of that prescription drug 
spending. For purposes of this hearing, we put together three 
charts, the first of which shows who is covered by drug 
coverage at the moment and who is not. If you look at the 
chart, what the bars show you are the coverage for different 
income levels, each measured as a fraction of the poverty 
level, so the first bar is from 0 to 100 percent of the Federal 
poverty level and the others rise to 400 percent of the poverty 
level or more. Shown in the chart are lighter gray areas, which 
are the fraction of beneficiaries in each income area who do 
not have drug coverage, and darker gray shading, for those who 
do have drug coverage. Roughly speaking, the population as a 
whole has about a 25 percent share, in our estimate, that does 
not have prescription drug coverage, and the share does not 
vary much by income class--from 22 percent to 32 percent.
    If we turn from who has coverage to how much individuals 
are spending, we get roughly the same story. The second chart 
looks at average prescription drug spending by Medicare 
beneficiaries. The bottom lighter gray area shows how much is 
paid out of pocket--about three-eighths is paid out of pocket--
and that share does not vary much by income. The top darker 
gray part shows the share paid by third parties, including 
other Federal programs. The average spending is about $1,500.
    If you put those two pieces together, coverage and average 
spending by individuals, we can show the total spending, in the 
final chart, for the Medicare population. Here, again, we can 
find total drug spending by income class, with the lighter gray 
area showing the fraction that is actually paid out of pocket--
and that turns out to be roughly the three-eighths I mentioned 
before--and the darker gray area, which has been covered by 
third parties already. The basic message, again, in this chart 
is that there is not much difference across income levels in 
the degree to which these costs come from out of pocket.
    So, I close with these pieces of information, which we 
think will be useful in framing the important issues that this 
Committee will face. I look forward to answering your 
questions.
    [The prepared statement of Dr. Holtz-Eakin follows:]

           Statement of Douglas Holtz-Eakin, Ph.D., Director,
                      Congressional Budget Office

    Chairman Thomas, Congressman Rangel, and Members of the Committee, 
I am pleased to be here with you today. I understand that the focus of 
this hearing is on expanding Medicare's coverage of prescription drugs, 
and I am prepared to discuss that topic in some detail. But I would 
first like to frame that discussion by looking at Medicare's overall 
financial picture, both in the near term and the long run. As this 
Committee well knows, Medicare is projected to consume an ever-larger 
piece of our national income just in delivering its current set of 
benefits. In determining whether and how to add prescription drug 
coverage to its benefit package--and the desirability of adopting other 
reforms to the program at the same time--lawmakers will face the 
challenge of balancing the needs of beneficiaries against the resulting 
pressures on the economy. To assist in that effort, I will describe the 
Congressional Budget Office's (CBO's) latest projections of 
prescription drug coverage and of drug spending for the Medicare 
population. I will then conclude my testimony by outlining some of the 
key issues that arise in designing a prescription drug benefit for 
Medicare.

Factors Driving Medicare Spending
    Under current law, Medicare spending--measured as a share of the 
economy--is projected to nearly quadruple by 2075, growing to more than 
9 percent of gross domestic product (GDP) from its current level of 2.5 
percent. As a consequence, Medicare will necessarily compete with other 
spending priorities for a much greater share of the Federal budget or 
with private-sector spending for a bigger share of the national 
economy--or with both. In thinking about how to address the substantial 
challenges that the Medicare program faces, however, it is important to 
recognize that they are not unique to Medicare; rather, they reflect 
the broader forces of an aging society, the rising costs of health care 
generally, and the looming long-range financial strains that will 
affect the Federal Government and the economy as a whole.
    Clearly, part of the challenge facing Medicare stems from the 
demographic trends that are making the country as a whole older. From 
1970 to 2010, the number of Americans ages 20 to 64 is projected to 
increase by nearly 80 million; the elderly population by 2010 will have 
grown by about 20 million, or roughly one-fourth as much. In contrast, 
for the period 2010 to 2030--when the baby-boom generation will 
retire--the number of working-age individuals is projected to grow by 
about 10 million, whereas the population ages 65 and older will 
increase by 30 million, or three times as much. The consequence of 
those diverging patterns is that the ratio of the elderly population to 
the population in its prime working years--which stood at 19 percent in 
1970--is projected to grow from 21 percent today to 35 percent by 2030. 
The ratio is then expected to continue to climb (albeit at a slower 
rate) and could reach 42 percent in 2075. In other words, the shift to 
an older society will accelerate as the baby-boom generation retires, 
and it will persist afterwards, making the changes that the nation 
faces--and their implications for the spectrum of Federal tax and 
spending policies--more than just temporary.
    Compounding those demographic pressures are the seemingly 
inexorable increases in health costs per person--but that issue, too, 
is not limited to Medicare. Nationally, health care expenditures as a 
percentage of GDP have more than doubled over the past several decades, 
growing from 7.0 percent in 1970 to 14.8 percent in 2002. On a per 
capita basis, national spending for health care (in 2002 dollars) 
increased from $1,321 in 1970 to $5,366 in 2002, or at an average rate 
of about 4.5 percent per year--which is about 2.4 percentage points 
faster than the growth of the underlying economy. The factors 
contributing to the trend in real (inflation-adjusted) per capita 
health care spending include expansions in insurance coverage, rising 
income, medical price inflation in excess of general inflation, and the 
aging of the population--but the major impetus has been the development 
and diffusion of new medical technology. At the same time, it should be 
noted that improvements in that technology--while costly--have 
increased the health care system's potential to deliver high-quality 
care. If the adoption of new technology is driven by the needs of 
patients, the value of those improvements may well exceed their cost.
    Over the 1970-2002 period, Medicare spending has risen even more 
rapidly than national health expenditures, growing eightfold even after 
adjusting for inflation. As a share of GDP, Medicare costs rose from 
0.7 percent in 1970 to their current level of 2.5 percent. Although 
cost growth on a per-enrollee basis has been volatile, it has also 
tended to rise at a much faster pace than the economy has grown. Over 
the period, real costs per enrollee grew more than twice as fast as the 
economy--specifically, at the rate of per capita GDP plus 2.8 
percentage points. One reason that total Medicare costs have grown more 
quickly than overall health costs is that the number of beneficiaries 
has grown more quickly than the U.S. population as a whole, owing both 
to program expansions and to the increase in the share of Americans who 
are elderly. In terms of costs per beneficiary, the growth of Medicare 
spending is due in part to the same factors that have driven increases 
in health care spending nationally, but it also reflects legislative 
and administrative expansions of the program's benefit package.
    In general, precisely determining each factor's effect on overall 
program spending is difficult. As an illustration, however, consider 
spending for services provided to fee-for-service program enrollees 
during acute care hospital stays (which now account for about one-third 
of Medicare's total costs). The program's total spending for those 
services grew by 261 percent between 1972 and 1998, after adjusting for 
general inflation (see Table 1). That growth in total spending is the 
product of three factors: increases in the number of Medicare 
beneficiaries; increases in the number of hospital admissions per 
beneficiary; and--the most important factor--increases in the real cost 
per admission. That cost nearly doubled over the period in real terms 
and accounted for 57.4 percent of the overall growth. Over the same 
period, the number of enrollees in the fee-for-service program 
increased by about 50 percent, contributing 30.3 percent of the rise in 
spending. The number of hospital admissions per beneficiary grew more 
slowly and accounted for only 12.3 percent of the increase in total 
costs.


           Table 1.--Sources of Fee-for-Service Medicare Cost Growth for Acute Care Hospital Services
----------------------------------------------------------------------------------------------------------------
                                                                                                     Percentage
                                                                                        Percentage    Share of
                                                                 1972         1998      Increase,       Total
                                                                                        1972-1998     Increase
----------------------------------------------------------------------------------------------------------------
Total Costs (Millions of dollars)                           21,744       78,522             261.1         100.0
----------------------------------------------------------------------------------------------------------------
Number of Beneficiaries (Millions)                               21.1         32.0           51.3          30.3
----------------------------------------------------------------------------------------------------------------
Admissions per Beneficiary                                        0.302        0.365         20.9          12.3
----------------------------------------------------------------------------------------------------------------
Cost per Admission (Dollars)                                 3,408        6,724              97.3          57.4
----------------------------------------------------------------------------------------------------------------
Source: Congressional Budget Office based on Department of Health and Human Services, Health Care Financing
  Administration, Health Care Financing Review: Medicare and Medicaid Statistical Supplement, 2000.
Note: The costs noted in the table (which are in 1998 dollars) reflect inpatient costs for fee-for-service
  enrollees at acute care hospitals.


    One valuable feature of such a breakdown is that it highlights the 
factors driving Medicare spending that lawmakers can influence and 
those that they cannot. In this case, costs per admission reflect the 
mix of, and prices for, therapies or services provided in an average 
admission. Today, policymakers can directly control only one of those 
two components: the price paid for a given service, which is updated 
annually as specified by statute. Thus, for example, lawmakers can seek 
to change the increase in payments for procedures such as a coronary 
artery bypass graft, but they do not control the share of total 
admissions accounted for by each procedure--which results from 
decisions made by doctors and their patients. The payment systems that 
are established in law do influence how doctors and other health care 
providers make treatment decisions. Similarly, features such as the 
cost sharing for those services can affect what beneficiaries choose to 
do. But the impact of changes in policy on those individual decisions 
is complicated and far from direct.
CBO's Projections of Medicare Spending Under Current Law
    With that historical view in mind, let me turn now to CBO's 
projections of Medicare spending for the next 10 years, which were 
updated in March. CBO projects that gross outlays for Medicare benefits 
will total $271 billion in 2003 and $3.9 trillion over the 2004-2013 
period (see Table 2). As a share of the economy, those Medicare outlays 
are projected to rise from 2.5 percent in 2003 to 2.9 percent in 2013, 
on average constituting 2.7 percent of GDP over the 2004-2013 period. 
After deducting projected premium payments by beneficiaries--which 
amount to $28 billion in 2003 and $461 billion over the 10-year 
period--CBO estimates that net spending for Medicare benefits will 
total $243 billion in 2003 and $3.4 trillion from 2004 through 2013. 
All of CBO's projections reflect the assumption that current law 
remains unchanged, thereby establishing the ``baseline'' for 
legislative proposals.
    Focusing on the program's growth rates, CBO projects that net 
spending for Medicare benefits will increase by 5.9 percent in 2003 and 
will grow at an average annual rate of 6.8 percent over the 2004-2013 
period. In recent years, the annual rate of growth of Medicare spending 
has varied considerably. Growth averaged 1.2 percent annually during 
the 1997-2000 period but has averaged more than 8 percent since then. 
Spending for benefits provided under Part B of Medicare (Supplementary 
Medical Insurance) grew particularly rapidly in 2002, driven by a 
significant rise in the volume and intensity of physician services and 
by increases of about 20 percent in spending for durable medical 
equipment and physician-administered pharmaceuticals. Costs for Part A 
of Medicare (Hospital Insurance) also rose sharply, including a 10 
percent increase in spending for inpatient hospital services.


             Table 2.--Summary of CBO's March 2003 Baseline Projections of Medicare Benefit Outlays
                                                (By fiscal year)
----------------------------------------------------------------------------------------------------------------
                                                                 Billions of Dollars            Average Annual
                                                       --------------------------------------   Rate of Growth,
                                                                                                   2004-2013
                                                               2003            2004-2013           (Percent)
----------------------------------------------------------------------------------------------------------------
Gross Benefit Outlays                                          271                3,880                     6.9
----------------------------------------------------------------------------------------------------------------
Premiums                                                       -28                 -461                     8.2
----------------------------------------------------------------------------------------------------------------
Net Benefit Outlays                                            243                3,419                     6.8
----------------------------------------------------------------------------------------------------------------
Source: Congressional Budget Office.
a. Outlays exclude spending by Medicare for quality improvement organizations, health care fraud and abuse
  control, and other administrative costs. Total spending on those activities is projected to be $5.4 billion in
  2003. Of that amount, $3.8 billion is subject to appropriation.


    The projected growth rates of Medicare's payments vary by service 
type. Total payments to hospitals for inpatient services and payments 
to physicians, which together account for two-thirds of the program's 
outlays, are the slowest-growing components of spending for fee-for-
service enrollees, respectively averaging 6.4 percent and 5.9 percent 
annually in CBO's baseline projections through 2013. By contrast, rates 
of growth for the costs of other services--for example, those provided 
by home health agencies and non-physician professionals--are projected 
to average 10 percent to 13 percent annually (but will still constitute 
a relatively small share of total Medicare spending).
    Over the next decade, CBO expects several factors to play a major 
role in the program's cost growth. Those factors include rising levels 
of enrollment in Medicare and automatic increases in payment rates for 
many services in the fee-for-service program (to adjust rates for 
rising input costs). CBO also projects changes in the use of Medicare's 
services, reflecting an increase in the number of services furnished 
per enrollee as well as a shift in the mix of services toward those 
that are higher priced and (often) more technologically advanced. In 
part offsetting the effects of those spending components on total costs 
will be small or negative updates (adjustments) to payment rates for 
physician services and smaller updates (relative to cost increases in 
the fee-for-service program) to the rates paid to Medicare+Choice 
plans.
    Specifically, increases in payment rates account for about 45 
percent of the projected rise in Medicare spending over the next 
decade; the other 55 percent is equally divided between increases in 
enrollment and changes in the quantity and mix of services delivered 
per beneficiary. As noted above, payment rates are the easiest factor 
for policymakers to control. Rates for many services are automatically 
adjusted for rising input costs. In the past, legislation has 
frequently limited those increases to less than the full change 
estimated for those costs. Since 1990, for example, updates to payment 
rates for hospital admissions have averaged about 1 percentage point 
less than the increase in the market-basket index used to measure 
increases in the cost of hospital inputs. Under current law, however, 
payment rates for services furnished by hospitals and many other 
providers will automatically rise by the full amount of the increase in 
estimated input costs, as a result of the expiration of many of the 
provisions contained in the 1997 Balanced Budget Act.
    Medicare's payment rates for physician services are subject to a 
very different update formula. Most recently, the Balanced Budget Act 
established an ongoing target for cumulative spending for physician 
services (and services that accompany physician visits). By statute, 
that target is automatically adjusted each year for changes in 
physicians' input costs and in the program's enrollment--plus the 
change in GDP per capita. (Future effects of enacted legislation and of 
regulation are also taken into account.) In the absence of per capita 
GDP growth, the real (inflation-adjusted) target for spending per 
enrollee remains unchanged. Increases in GDP per capita thus act as an 
allowance to cover increases in the number and average cost of services 
being furnished per enrollee as technology and medical practices evolve 
over time. If total spending for physicians deviates from that 
allowance--in either direction--then the annual updates to payment 
rates are adjusted over a period of several years to bring cumulative 
spending back in line with the target.
    By the time payment rates were set for 2002, expenditures for 
physician services had exceeded the cumulative target, so rates for 
those services were reduced by about 5 percent, and a further reduction 
of 4.4 percent was originally scheduled for 2003. However, the 
Department of Health and Human Services invoked a provision of the 2003 
Consolidated Appropriations Resolution to increase the cumulative 
target for 2002. As a result, payment rates for physician services in 
2003 were increased by 1.6 percent.
    Nevertheless, CBO projects that spending for physician services 
will again exceed the target in 2003 and remain above it on a 
cumulative basis through 2013. Therefore, in the absence of further 
legislative action, payment rates for those services are likely to 
decline (in absolute terms) for the next several years. (For example, 
last month the Centers for Medicare and Medicaid Services released a 
very preliminary estimate of the physician fee schedule update for 
calendar year 2004 indicating that payment rates could be cut by 4.2 
percent.) At the same time, the total volume of services provided will 
continue to rise as the number of beneficiaries increases and the 
number of services provided per beneficiary grows. As a result, CBO 
projects that total Medicare spending for physician services--which is 
the product of the prices paid and quantities used for the mix of 
services provided--will rise each year through 2013, on both an 
aggregate and a per capita basis. I should reiterate here that those 
projections reflect CBO's best estimate of what will occur under the 
assumption that no changes are made in current law; in the past, 
lawmakers have often acted to modify those payments, whether to correct 
discrepancies between payment rates and the costs providers incur or 
for other purposes.

Medicare's Long-Term Financing Challenges
    Although the 10-year budget window for Medicare now includes 
enrollment of the first wave of the baby-boom generation--those 
individuals born between 1946 and 1948, who will turn 65 by 2013--a 
complete picture of the program's fiscal outlook requires an even 
longer view. Toward that end, CBO projected the cost of Medicare as a 
share of GDP out to 2075 to show how much of the country's production 
of goods and services would be needed to pay for the program as it is 
currently structured. Although we are continuing to refine our 
projection models, CBO currently estimates that Medicare's costs as a 
percentage of GDP will rise from 2.5 percent in 2003 to 9.2 percent in 
2075. Approximately 30 percent of that growth is due to society's aging 
and the resulting increase in the number of Medicare beneficiaries; the 
remaining 70 percent is attributable to the growth of health care costs 
per enrollee in excess of the rate of growth of GDP per capita (see 
Figure 1).
    For a sense of the magnitudes involved, if the Medicare program's 
costs accounted for 9.2 percent of GDP today, they would equal half of 
what is now spent by the entire Federal Government. If the program's 
higher costs were simply added to current Federal spending, total 
Federal receipts (which currently absorb about 18 percent of GDP) would 
have to be one-third larger to balance the budget. And if those 
increased costs were paid for entirely through a payroll-based tax, the 
rate for Social Security and Medicare, now set at 15.3 percent on the 
earnings of most workers, would have to more than double--a rise equal 
to roughly $6,000 per worker (that is, $3,000 each for the worker and 
his or her employer).

       Figure 1.--Projected Long-Term Growth of Medicare Spending
                          (Percentage of GDP)

[GRAPHIC] [TIFF OMITTED] T9405A.001

    Source: Congressional Budget Office.

    Of course, the fiscal challenges facing Medicare will occur in 
parallel with those for Social Security and Medicaid. Those three 
programs now absorb 8 percent of GDP, but if CBO's projections hold, 
that figure will rise to 14 percent by 2030. Beyond that point, 
spending pressures will only intensify, with life expectancy continuing 
to increase and health costs continuing to grow. CBO projects that by 
2075, the cost of the three programs could climb to 21 percent of GDP, 
the largest portion of which would be attributable to Medicare. To 
accommodate the increase in spending, either taxes would need to be 
raised dramatically or spending on other Federal programs would have to 
be curtailed severely--or Federal borrowing would soar.
    For Medicare, the most significant factor affecting those 
projections is that annual growth of spending per beneficiary is 
expected to increase faster than per capita GDP growth--but much less 
quickly than in the past. CBO's current projection assumes that per 
capita Medicare spending will eventually grow 1 percentage point faster 
than per capita GDP, a rate that is substantially slower than the 2.8 
percentage-point ``excess cost'' rate that the program has experienced 
over the past 32 years (part of which has been due to program 
expansions). CBO's assumption of an eventual deceleration in the 
relative rise of health care costs is consistent with that of the 
Medicare trustees (as well as others) and reflects the view that forces 
within the health care sector will operate to slow the rate of growth 
somewhat.
    But that assumption might be too optimistic, and even seemingly 
small deviations from it could have significant economic implications 
when costs are projected over long periods. For example, if the growth 
of per capita Medicare costs slowed only to the rate of per capita GDP 
growth plus 1.5 percentage points, then program outlays would equal 5.4 
percent of GDP in 2030 and 13.2 percent in 2075 (and if the health 
sector as a whole grew at that rate, it would account for more than 
half of the economy's output by 2075). Adding to the uncertainty is the 
potential for program expansions, because enacting a new prescription 
drug benefit or easing existing limits on payments to providers could 
exacerbate the rising long-term spending trajectory.
Prescription Drug Coverage and Spending
    I would now like to describe CBO's latest projections of 
prescription drug coverage and spending for the Medicare population 
under current law. I offer them not just because they serve as the 
basis for our estimates of legislative proposals to add a drug benefit 
to Medicare but also because they may provide useful insights for the 
design of such proposals.
    Most Medicare beneficiaries now have coverage for prescription 
drugs at some point in the year, but the extent of that coverage varies 
widely. CBO's analysis of the Medicare Current Beneficiary Survey 
indicates that in 2000 (the most recent year for which data are 
available), 75 percent of the Medicare population--or roughly 30 
million individuals--had some form of insurance coverage for the costs 
of prescription drugs for at least part of the year; 25 percent--or 
roughly 10 million beneficiaries--had no drug coverage. Beneficiaries 
who have coverage for their drug costs obtain it from a variety of 
sources. For example, nearly 30 percent of Medicare beneficiaries 
obtained coverage through employer-sponsored retiree benefits, and 
another 16 percent had coverage through the Medicaid program. About 12 
percent of beneficiaries are estimated to have had drug coverage 
through individually purchased Medigap policies, while the remainder 
obtained coverage through a Medicare+Choice plan or from another State 
or Federal program.
    CBO's estimates of the total number of Medicare beneficiaries 
grouped by income and the share of them who lacked drug coverage 
throughout 2000 appear in Figure 2. Although the fraction of 
beneficiaries without coverage varied from 32 percent (for those with 
income between 100 percent and 150 percent of the Federal poverty 
level) to 22 percent (for those with income exceeding 400 percent of 
poverty), CBO's main finding is that the differences across the income 
spectrum are not dramatic. The varying degrees of coverage are likely 
to reflect both difficulties in obtaining private drug coverage as well 
as rational ``nonpurchase'' of such coverage by beneficiaries with low 
levels of drug spending.
    Clearly, the extent of the drug coverage that Medicare 
beneficiaries have today--and whether and how that coverage should be 
added to Medicare--is of central interest to policymakers, for two 
reasons: the elderly and disabled as a group use substantial amounts of 
prescription drugs, and their spending for such drugs has been rising 
rapidly in recent years. CBO's analysis indicates that Medicare 
beneficiaries bought about $1,500 worth of drugs, on average, in 2000 
and that more than 90 percent of beneficiaries filled at least one 
prescription that year. Overall, about three-eighths of those costs 
were paid out of pocket, a figure that combines the payments of those 
without coverage (who pay the full cost of their drugs) and those with 
coverage (who incur copayments and deductibles). When average drug 
spending and out-of-pocket costs for Medicare beneficiaries are broken 
down by beneficiaries' level of income, again, the main finding is that 
average spending--both total and out-of-pocket--is remarkably similar 
for all income groups (see Figure 3).

  Figure 2.--Medicare Beneficiaries in 2000, by Income Level and Drug 
                                Coverage
                      (Millions of beneficiaries)

[GRAPHIC] [TIFF OMITTED] T9405A.002

    Source: Congressional Budget Office.

    As Figure 4 indicates (see page 12), an important consideration in 
designing any Medicare drug benefit is how it will affect the out-of-
pocket costs of enrollees as well as the large amount of payments 
currently made by third parties (including other Federal programs). For 
example, in 2000, the 8.5 million Medicare beneficiaries with income 
between 200 percent and 300 percent of the poverty level used about $13 
billion worth of drugs. Beneficiaries paid about $5 billion of that 
cost directly, and $8 billion was paid on their behalf. (Beneficiaries 
ultimately pay part of those covered costs if they pay a premium for 
their coverage.)

   Figure 3.--Average Prescription Drug Spending in 2000 by and for 
                         Medicare Beneficiaries
                               (Dollars)
[GRAPHIC] [TIFF OMITTED] T9405A.003

    Source: Congressional Budget Office.

CBO's Projections of Future Drug Spending
    As the above data illustrate, elderly and disabled Medicare 
beneficiaries now consume substantial amounts of drugs. In addition, 
their spending is projected to continue growing at a rapid pace (as is 
drug spending for the country as a whole). For the period 2004 through 
2013, CBO estimates that spending for prescription drugs by and on 
behalf of the Medicare population will total roughly $1.8 trillion, or 
nearly 50 percent of the projected $3.9 trillion in Medicare outlays 
over that same period. Over that period, CBO expects Medicare 
beneficiaries' average spending for prescription drugs to climb 
quickly--at an average annual rate of about 9 percent--even in the 
absence of a Medicare drug benefit.
    CBO's current estimate of total drug spending is about 4 percent 
higher than its projection last year for the 2003-2012 period. 
Typically, shifting the projection period forward by one year adds a 
relatively expensive year and drops a relatively inexpensive one, 
leading to a larger increase. This year's estimate, however, reflects 
two offsetting factors: new information about the degree to which drug 
spending is underreported in current surveys (which slightly lowered 
the starting point for the projections); and somewhat lower projections 
of the rate of growth of drug spending (the result, in part, of slower-
than-expected economic growth in the near term).

Figure 4.--Total Prescription Drug Spending in 2000 by and for Medicare 
                             Beneficiaries
                         (Billions of dollars)

[GRAPHIC] [TIFF OMITTED] T9405A.004

    Source: Congressional Budget Office.

Issues in Designing a Drug Benefit
    The financial challenges already facing the Medicare program and 
the significant sums that projections indicate its beneficiaries will 
spend on drugs combine to make designing a drug benefit for that 
program a formidable task. In considering how to design such a benefit, 
it is useful to begin with some key principles of insurance design 
that--as an economist--help me think through the complex issues 
involved and are related to some of the options with which the Congress 
is now grappling.
    The first and foremost issue to confront is the structure of the 
benefit that is provided--that is, the deductible and cost sharing it 
will require. In general, well-designed insurance should reduce the 
risk of catastrophic financial losses yet leave individuals to cover 
their routine, expected expenditures with their own resources. Such a 
design would also reflect concern about the phenomenon known as ``moral 
hazard''--in which further coverage would induce additional and perhaps 
excessive demand for services.
    Applying that principle would suggest that Medicare's drug benefit 
should focus on protecting beneficiaries against very high drug costs. 
If Medicare adopted some kind of catastrophic approach, most enrollees 
would receive no payments in any given year, but they would nonetheless 
benefit from being protected against the possibility of catastrophic 
expenses. Several factors related to the nature of drug spending, 
however, complicate the application of a ``pure insurance'' approach. 
The two most important factors are the degree to which the distribution 
of drug spending is skewed and the degree to which it is persistent.
Concentration and Persistence of Drug Spending
    Although most Medicare enrollees use some prescription drugs, the 
bulk of such spending is concentrated among a much smaller group. In 
2000, about 26 percent of enrollees had expenditures of $2,000 or more, 
and together they accounted for 65 percent of total drug spending by 
the Medicare population. At the same time, 32 percent of beneficiaries 
had expenditures of $500 or less, making up about 4 percent of total 
spending.
    Of course, skewed annual expenses by themselves are actually 
typical of insurance markets, since insurance is usually purchased to 
protect against a small but relatively random risk of a large loss. 
What makes insurance for drug coverage difficult to provide is that 
prescription drug costs persist over time for the same enrollees. In 
particular, a large share of drug spending is associated with treatment 
of chronic conditions--such as hypertension, cardiovascular disease, 
and diabetes--which are often evident by the time individuals become 
eligible for Medicare. The result is that potential enrollees have 
important ``private information'' about their future drug costs. That 
fact makes stand-alone drug coverage particularly susceptible to 
adverse selection, in which enrollment is concentrated among those who 
expect to receive the most in benefits.
    Indeed, those same facts help explain why beneficiaries may find it 
difficult today to purchase private coverage for prescription drugs--or 
why catastrophic protection is virtually unavailable except through 
subsidized retiree coverage or Medicaid. If beneficiaries were given a 
choice about whether and when to purchase individual prescription drug 
coverage, people with high drug costs would be most likely to 
participate. That would drive premiums up, which in turn would reduce 
enrollment as enrollees with below-average drug costs dropped out. In 
the extreme, that spiral could lead to a market failure in which no 
insurance was sold, even if most people would be willing to pay more 
than the average cost of a policy that had broad enrollment. Those 
theoretical pressures are well illustrated in practice by today's 
market for new Medigap policies that include a drug benefit (which 
cover as much as half of an enrollee's drug costs but cap the benefit 
at $1,250 or $3,000 per year). Insurers that offer such policies often 
charge a premium that represents a very large share of the maximum 
potential drug benefit--to reflect the average cost of their enrollees. 
Similarly, the drug coverage available through Medicare+Choice plans is 
generally subject to caps.
    Most proposals for a Medicare drug benefit have sought to correct 
for such market failures by including coverage for catastrophic drug 
costs but, accordingly, must also include measures designed to avoid an 
adverse selection spiral. One potential approach would be to make 
enrollment mandatory. A related option would integrate drug coverage 
into the benefit package for Part B of Medicare (and charge a 
correspondingly higher premium), so that beneficiaries could not 
separate their choice of whether to obtain drug coverage from their 
decision to purchase coverage for less predictable health costs.
    But most of the drug benefit proposals developed in recent years 
have sought to keep enrollment in the benefit as a separate option for 
the elderly and disabled. To mitigate the potential for adverse 
selection, they would use some or all of the following three methods:

       Restrict Participation. Most proposals have either 
given enrollees only one opportunity to choose the drug benefit--at the 
time they first become eligible for it--or imposed a substantial 
premium surcharge on those who delay enrollment. (Otherwise, 
beneficiaries with low drug costs would simply wait until they needed 
coverage to enroll.)
       Provide Up-Front Coverage. Many proposals have sought 
to make enrollment more attractive for beneficiaries with low drug 
costs by providing some coverage for their initial drug expenditures--
for example, covering a substantial share of costs after beneficiaries 
meet a deductible that can be as low as $100.
       Offer High Premium Subsidy Rates. The extent of Federal 
subsidization of premiums for a drug benefit is a key determinant of 
total Federal costs for such a program both because of the direct costs 
and because the availability of subsidies would lead employers and 
State Medicaid programs to encourage or require full participation. 
However, such subsidies would also serve to encourage other 
beneficiaries with relatively low drug costs to enroll in the benefit. 
Most recent proposals have contained relatively high subsidy rates--67 
percent or higher--which mean that enrollees would pay one-third or 
less of the average covered costs through their monthly premiums.
The Administration of a Medicare Drug Benefit
    The way in which a drug benefit is administered also affects its 
costs, and the options for administration involve many of the same 
trade-offs between insurance and incentives that arise in designing the 
benefit itself. Most recent proposals have envisioned adopting the 
common private-sector approach of using pharmacy benefit managers 
(PBMs) to process drug claims. Those proposals would also give 
beneficiaries a range of drug plans from which to choose, either in 
conjunction with their choice of medical coverage or as a stand-alone 
benefit. The extent to which the organizations that administered a 
Medicare drug benefit could effectively constrain its costs would 
depend on the organizations' having both the authority and the 
incentive to use the various cost-control mechanisms at their disposal. 
Proposals have differed, however, in the nature and extent of the risk 
that the entities responsible for administering the benefit would 
assume, the kind of restrictions that would be placed on them in 
managing drug costs, and the structure of the competition among those 
entities to enroll and serve beneficiaries.
    Private health plans use PBMs to process claims and negotiate price 
discounts with drug manufacturers and dispensing pharmacies. PBMs also 
try to encourage the use of certain drugs, such as generic, preferred-
formulary, or mail-order pharmaceuticals--in part so that they can 
obtain lower prices for those preferred drugs that have competitors. In 
addition, because of their centralized records for each enrollee's 
prescriptions, they may help prevent adverse drug interactions and take 
other steps to help beneficiaries manage their own drug use.
    In the private sector, PBMs often have considerable leeway in the 
tools they can use, but they do not assume any insurance risk for the 
drug benefit (although they may be guided or selected by an employer or 
insurer who does bear the residual risk). At most, they may be subject 
to a bonus or a penalty added to their administrative fee, which is 
based on how well they meet prespecified goals for their performance. 
Some proposals have envisioned having PBMs or similar entities 
administer a Medicare drug benefit in that way--accepting ``performance 
risk'' but not ``insurance risk.'' In such models, all costs for 
benefit claims would be paid by the Federal Government as they were 
incurred.
    Other proposals have adopted a different model, more akin to the 
risk-based competitive model characteristic of Medicare+Choice plans. 
Those proposals envision multiple risk-bearing entities (such as 
partnerships between PBMs and insurers) that would compete to serve 
enrollees. Enrollees would have some choice among providers, so that 
beneficiaries who were willing to accept more-restrictive rules (such 
as a closed formulary) in return for lower premium costs could do so, 
whereas others could select a more expensive provider with fewer 
restrictions. If the entities bore all of the insurance risk for the 
drug benefit--that is, if they received a fixed per capita payment for 
each enrollee--they would have strong incentives to use whatever cost-
control tools were permitted. However, such tools might be unattractive 
to many beneficiaries, and the plans' administrators would also have 
strong incentives to try to achieve favorable selection by avoiding 
enrollees with the highest spending.
    An additional concern about this model has been that entities might 
be unwilling to participate if they had to assume the full insurance 
risk for a stand-alone drug benefit. To mitigate that concern, 
proposals have included federally provided reinsurance for high-cost 
enrollees as well as so-called risk-adjustment mechanisms that would 
vary the per capita payments on the basis of enrollees' 
characteristics, such as their age or previous disease diagnoses. 
(Reinsurance means that the Federal Government shares part or all of 
the claims costs of high-cost enrollees.) Although reinsurance would 
reduce the incentives to avoid the highest-cost enrollees that risk-
bearing plans face, it would also tend to weaken the plans' incentives 
to control costs commensurately.
    Complicating matters further, the incentives to control drug costs 
faced by entities administering a Medicare drug benefit would not 
depend solely on how they were paid; the financial incentives that 
beneficiaries faced would also be a key consideration. Such incentives 
might include lower beneficiary premiums for joining plans that could 
deliver the required benefits for a lower overall cost, as well as 
smaller out-of-pocket payments in plans that were able to negotiate 
lower prices for the drugs they covered. If plans competed primarily on 
the basis of the comprehensiveness of the coverage they provided, 
however, Federal expenditures would probably be higher than if plans 
competed on cost factors. Moreover, to devise a proposal that would 
require plans to bear insurance risk but not allow beneficiaries' 
premiums to vary with their choice of plan appears to be difficult.
    Although much depends on a proposal's specific design and details, 
a drug benefit could be structured so that entities bearing some 
insurance risk would choose to provide it; further, such coverage would 
probably be available across the country. That conclusion, which stands 
in contrast to the experience of the Medicare+Choice program, is based 
in part on the fact that the kind of competing pharmacy networks needed 
to provide such a drug benefit are already well established nationwide. 
At the same time, CBO concludes that plans bearing insurance risk would 
incur additional costs that would not be borne by PBMs that are subject 
only to performance risk. Whether and to what extent those added costs 
might offset any reductions in Federal costs that accrued from having 
plan administrators face insurance risk would also depend on the 
specific provisions of the proposal.
    Finally, recent discussions have included the notion of linking 
drug coverage with reforms of the delivery mechanism for Medicare's 
benefits. For example, the Bush Administration has put forward a set of 
principles for Medicare reform that suggests an ``integrated'' approach 
combining drug benefits and enrollment in private health plans. The 
budgetary implications of such an approach are, however, unclear--the 
Administration estimated that its initiative would cost a total of $400 
billion through 2013 but did not submit sufficient details for CBO to 
make its own estimate. CBO is preparing to estimate the effects of any 
such proposals and looks forward to working with the Congress if and 
when such initiatives are introduced as legislation.
Conclusion
    In conclusion, I would be remiss if I did not emphasize the 
important trade-offs involved in all of the policies now under 
consideration. Even when considered in isolation, a Medicare drug 
benefit might address a number of objectives--but objectives that might 
be thought desirable in the abstract are often mutually incompatible, 
necessitating difficult choices. For example, providing extensive drug 
coverage to all Medicare beneficiaries at a low cost to all parties is 
not possible; either enrollees' premiums or the government's subsidy 
costs would be high. If most of the costs were paid through enrollees' 
premiums to keep Federal spending low, some Medicare beneficiaries 
would be unwilling or unable to participate in the program, 
particularly if coverage was limited to catastrophic expenses. If, 
instead, costs were limited by capping the annual benefits paid to each 
enrollee, the program would fail to protect participants from the 
impact of catastrophic drug costs. Proposals have taken various 
approaches to balance those competing objectives.
    Looking at the Medicare program as a whole, the choices may be even 
more stark. If the program continues to operate as it is currently 
structured, its costs will rise significantly--even in the absence of 
program expansions such as a prescription drug benefit. In light of 
that outlook, policymakers may wish to incorporate two features in 
their approach to Medicare policy: a recognition of the larger economic 
and budgetary trade-offs, and consideration of the program structure 
that would best support Medicare's overall objective of providing 
financing for high-quality medical care for the elderly and disabled.
    With regard to economic and budgetary trade-offs, two issues stand 
out. First, to the extent that the U.S. economy grows at a healthy 
pace, it will be better able to meet the Medicare population's demands 
for health care. Put differently, the overall level of national income 
available in the future constitutes the reservoir from which the 
resources for both private needs and public programs will be drawn, and 
the nation must endeavor, in making public policy, to enlarge that 
reservoir to the greatest degree possible. Second, the potential 
pressures on the Federal budget from Medicare and other sources will 
necessitate trade-offs with other spending priorities if Federal 
programs are to remain close to their historical fraction of national 
income.
    Alternatively, public policy may steer a course toward devoting a 
larger fraction of the Federal budget and the economy as a whole to 
Medicare. Even if that occurs, it will be desirable to use those 
Medicare funds as efficiently as possible--to purchase the highest-
value care with each dollar. Medicare beneficiaries (or their 
families), together with their health care providers, are best 
positioned to guide the use of additional dollars and to choose 
services that meet therapeutic demands and match individual tastes. 
Providing those parties with a broader range of choices and improved 
information, and ensuring their sensitivity to the cost of those 
services, should facilitate better decisionmaking. At the same time, an 
appropriate balance must be struck between providing stronger financial 
signals to beneficiaries about the cost of their care and providing 
protection against greater financial exposure--in the program as a 
whole and in any drug benefit that is added to it.
    This concludes my testimony, and I look forward to answering any 
questions that the Committee may have.

                                 

    Chairman THOMAS. Thank you very much, Doctor. Mr. Walker?

    STATEMENT OF THE HONORABLE DAVID M. WALKER, COMPTROLLER 
            GENERAL, U.S. GENERAL ACCOUNTING OFFICE

    Mr. WALKER. Thank you, Mr. Chairman, Ranking Member Rangel. 
It is a pleasure to be back before the full Committee on Ways 
and Means to discuss Medicare's financial condition and 
proposals to add an outpatient prescription drug benefit. I 
will hit the highlights, if I can, Mr. Chairman.
    There are growing concerns about gaps in the Medicare 
program, most notably the lack of outpatient prescription drug 
coverage, which can leave Medicare's most vulnerable 
beneficiaries with high out-of-pocket costs. At the same time, 
however, the recent publication of the 2003 trustees Annual 
Report reminds us that Medicare, based on its current design, 
with no prescription drug benefit, already faces a huge 
projected financial imbalance and that has worsened 
significantly in the past year.
    Furthermore, as the Medicare trustees made clear over 10 
years ago, the current Medicare program is not fiscally 
sustainable in its present form. In fact, that was done in the 
year that I was a trustee of Social Security and Medicare. In 
10 years, Hospital Insurance (HI) Trust Fund outlays will begin 
to exceed tax revenues, and by 2026, the HI Trust Fund will be 
exhausted. However, trust fund insolvency does not mean that 
the program will cease to exist. Program tax revenues will 
cover a portion of projected annual expenditures thereafter.
    In the face of these short-term and long-term cost 
pressures, I continue to maintain that substantive financing 
and programmatic reforms are necessary to put Medicare on a 
sustainable footing for the future. The trustees' intermediate 
projections in the 2003 report show that program outlays are 
expected to begin to exceed program tax revenues in 2013. That 
is when we go negative cash flow. Cash is key, not trust fund 
solvency. In fact, trust fund solvency can be misleading and 
give people a false sense of security as to not only the state 
of this program, but also Social Security.
    To finance these cash deficits, HI will have to draw on 
special issue Treasury securities acquired during the years of 
surpluses. To redeem those securities, the government will have 
to obtain cash through a combination of increased taxes, 
spending cuts, and/or increased borrowing from the public, 
through publicly held debt. Neither the decline in the cash 
surpluses nor the cash deficits will affect the payment of 
benefits for a member of years. The negative cash flow will 
place increased pressure on the Federal budget to raise 
resources necessary to meet the program's ongoing costs. This 
pressure will only increase when Social Security begins to 
experience a negative cash flow just a few short years after 
the Medicare program.
    Importantly, the HI Trust Fund measure provides no 
information on Supplemental Medical Insurance (SMI), or Part B, 
SMI. The SMI's expenditures, which currently account for about 
43 percent of total Medicare spending, are projected to grow 
even faster than HI.
    Ultimately, the critical question is not how much the trust 
fund has in assets, but whether the government as a whole and 
the economy at large can afford the promised benefits now and 
in the future, and at what cost to other claims on available 
resources. As shown in the next chart, Medicare, Medicaid, and 
Social Security have already grown from 13 percent of Federal 
spending in 1962--again, before Medicare and Medicaid were 
enacted into law--to 42 percent of Federal spending in 2002. 
These percentages are expected to continue to increase in 
future years.
    As the next chart shows, GAO prepares long-term budget 
simulations twice a year, based upon CBO data and then going 
out much further, that seek to illustrate the likely fiscal 
consequences of the coming demographic tidal wave and rising 
health care cost. These simulations continue to show that to 
move into the future with no changes in Federal retirement and 
health programs is to envision a very different role for the 
Federal Government. In addition, while additional economic 
growth would help to ease our burden, the projected fiscal gap 
is too great for us to grow our way out of the problem.
    At the same time, it is important to look beyond the 
Federal budget to the economy as a whole. If we look at the 
next chart, we will see that Medicare, Medicaid, and Social 
Security are projected to represent an ever-increasing 
percentage of the overall economy. Under the 2003 trustees' 
intermediate estimates and the CBO's most recent long-term 
Medicare estimates, spending for these entitlement programs 
combined will grow to 14 percent of GDP in 2030 from today's 
8.4 percent.
    Despite a common awareness of Medicare's current and future 
fiscal plight, pressure has been building to address recognized 
gaps in Medicare's coverage, especially the lack of a 
prescription drug benefit and protection against financially 
devastating medical costs. Filling these gaps would add 
expenses to an already fiscally overburdened program. Under the 
trustees' 2003 intermediate assumptions, the present value of 
HI's Part A's actuarial deficit in current dollars is $6.2 
trillion. We would have to have $6.2 trillion today invested at 
Treasury rates in order to fund the gap for Part A alone, a 20-
percent increase from last year.
    As a result, it would be prudent for the Congress to 
consider tackling the greatest needs first and for making any 
benefit additions part of a larger structural reform effort. In 
addition, Congress may want to adopt a Medicare Hippocratic 
oath, namely, do not make Medicare's already huge financial 
imbalance worse.
    In closing, Medicare's financial challenge is very real and 
growing. The 21st century has arrived, and our demographic 
tidal wave is on the horizon. Frankly, we know that 
incorporating a prescription drug benefit in the existing 
Medicare program will add hundreds of billions of dollars to 
the program spending just over 10 years.
    Finally, in my view, Congress should consider the estimated 
discounted present value of any major tax or spending actions 
like this as an integral part of any related discussion and 
debate and prior to enactment of any related legislation. This 
information is critical in light of our long-range fiscal 
challenge and the Congress' overall stewardship obligations to 
the American people.
    Thank you, Mr. Chairman. I am happy to answer any questions 
you may have.
    [The prepared statement of Mr. Walker follows:]

 Statement of The Honorable David M. Walker, Comptroller General, U.S. 
                       General Accounting Office

    Mr. Chairman and Members of the Committee:
    I am pleased to be here today as you discuss issues related to an 
outpatient prescription drug benefit for Medicare beneficiaries. There 
are growing concerns about gaps in the Medicare program, most notably 
the lack of outpatient prescription drug coverage, which may leave 
Medicare's most vulnerable beneficiaries with high out-of-pocket costs. 
Recent estimates suggest that, at any point in time, about a third of 
Medicare beneficiaries lack prescription drug coverage. The rest have 
at least some drug coverage through various sources--most commonly 
employer-sponsored health plans--although recent evidence indicates 
that this coverage is beginning to erode.
    At the same time, however, the recent publication of the 2003 
Trustees' Annual Report reminds us that Medicare in its current 
condition--with no prescription drug benefit--already faces a huge 
projected financial imbalance that has worsened significantly in the 
past year. Furthermore, as the Medicare trustees made clear over 10 
years ago, the current Medicare program is not fiscally sustainable in 
its present form.
    In 10 years, Hospital Insurance (HI) Trust Fund outlays will begin 
to exceed tax receipts, and by 2026 the HI Trust Fund will be 
exhausted. However, trust fund insolvency does not mean the program 
will cease to exist; program tax revenues will continue to cover a 
portion of projected annual expenditures.\1\
---------------------------------------------------------------------------
    \1\ Under the Trustees 2003 intermediate assumptions, revenues from 
the HI payroll tax and the taxation of certain Social Security benefits 
are initially projected to cover about three-fourths of projected 
expenditures once the trust fund is exhausted. This ratio, however, is 
projected to decline rapidly.
---------------------------------------------------------------------------
    The huge fiscal pressures created by the retirement of the baby 
boom generation and rising health care costs are on our 10-year budget 
horizon. Between now and 2035, the number of people age 65 and older 
will double. Federal health and retirement spending are expected to 
surge as people live longer and spend more time in retirement. In 
addition, advances in medical technology are likely to keep pushing up 
the cost of providing health care. Moreover, the baby boomers will have 
fewer workers to support them in retirement.
    We must also remember that Medicare has grown substantially as a 
percent of the Federal budget since its enactment in 1965. In addition, 
it is expected to represent an increasing percentage of the Federal 
budget in the years ahead. After a brief slowdown in the late 1990s, 
Medicare spending growth has recently accelerated. In fiscal year 2001, 
growth in program spending reached nearly 9 percent, with spending on 
certain services increasing much more rapidly. For example, spending 
for home health services grew about 30 percent and spending for skilled 
nursing facility care grew slightly over 20 percent. For the first 5 
months of fiscal year 2003, Medicare spending has been growing at 7.6 
percent.\2\
---------------------------------------------------------------------------
    \2\ Congressional Budget Office, Monthly Budget Review (Washington, 
D.C.: Mar. 10, 2003).
---------------------------------------------------------------------------
    A significant problem that hobbles Medicare's ability to achieve a 
desirable degree of efficiency is that the program too often pays 
overly generous rates for certain services and products. For example, 
for certain services, our recent work has shown substantially higher 
Medicare payments relative to providers' costs--as much as 35 percent 
higher for home health care and 19 percent higher for skilled nursing 
facility care.\3\ Similarly, Medicare has overpaid for various medical 
products. In 2001, we reported that Medicare paid over $1 billion more 
than other purchasers in 2000 for certain outpatient drugs that the 
program covers. Excessive payments hurt not only the taxpayers but also 
the program's beneficiaries or their supplemental insurers, as 
beneficiaries are generally liable for copayments equal to 20 percent 
of Medicare's approved fee. For certain outpatient drugs, Medicare's 
payments to providers were so high that the beneficiaries' copayments 
exceeded the price at which providers could buy the drugs. The Centers 
for Medicare & Medicaid Services (CMS) has not acted on our 
recommendation that Medicare establish payment levels for drugs more 
closely related to actual market transaction costs, using information 
available to other public programs that pay at lower rates.\4\
---------------------------------------------------------------------------
    \3\ See U.S. General Accounting Office, Medicare Home Health Care: 
Payments to Home Health Agencies Are Considerably Higher than Costs, 
GAO-02-663 (Washington, D.C.: May 6, 2002) and Skilled Nursing 
Facilities: Medicare Payments Exceed Costs for Most but Not All 
Facilities, GAO-03-183 (Washington, D.C.: Dec. 31, 2002).
    \4\ U.S. General Accounting Office, Medicare: Payments for Covered 
Outpatient Drugs Exceed Providers' Costs, GAO-01-1118 (Washington, 
D.C.: Sept. 21, 2001).
---------------------------------------------------------------------------
    In the face of these short-term and long-term cost pressures, I 
continue to maintain that substantive financing and programmatic 
reforms are necessary to put Medicare on a sustainable footing for the 
future. These fundamental reforms are vital to reducing the program's 
growth, which threatens to absorb ever-increasing shares of the 
nation's budgetary and economic resources. Thus, any proposals to help 
seniors with the costs of prescription drugs would need to be carefully 
crafted to avoid further erosion of the projected financial condition 
of the Medicare program. Stated differently, it will be prudent to 
adopt a modified Hippocratic oath for Medicare reform--namely, any such 
reform proposals should ``do no further harm'' to Medicare's already 
serious long-range financial imbalance.
    As you deliberate on ways to modernize Medicare's benefit package 
while striving for program sustainability, I would like to highlight 
several key considerations:

       The traditional measure of HI Trust Fund solvency is a 
misleading gauge of Medicare's financial health. Long before the HI 
Trust Fund is projected to be insolvent, pressures on the rest of the 
Federal budget will grow as HI's projected cash flow turns negative and 
the gap between program tax revenues and expenditures escalates. 
Moreover, a focus on the financial status of HI ignores the increasing 
burden Supplemental Medical Insurance (SMI)--Medicare Part B--will 
place on taxpayers and beneficiaries.
       GAO's most recent long-term budget simulations continue 
to show that, absent meaningful entitlement reforms, demographic trends 
and rising health care spending will drive escalating Federal deficits 
and debt. To obtain budget balance, massive spending cuts, tax 
increases, or some combination of the two would be necessary. Neither 
slowing the growth of discretionary spending nor allowing the 2001 tax 
reductions to sunset will eliminate the imbalance. In addition, while 
additional economic growth will help ease our burden, the potential 
fiscal gap is too great to grow our way out of the problem.
       Under the huge budgetary pressures that we are sure to 
face in the coming years, we must set priorities so that any benefit 
expansions are in line with available resources. In this regard, the 
application of basic health insurance principles to any proposed 
benefit could help moderate the cost for both beneficiaries and 
taxpayers. Under these principles, beneficiaries receive protections 
against the risk of catastrophic medical expenses while remaining 
conscious of the cost of care through their premium contributions and 
cost-sharing arrangements. Given our already huge Medicare financial 
imbalance, it is also important that benefit expansion proposals 
include targeting mechanisms to ensure that Federal support is directed 
at the beneficiaries with the greatest financial risk.
       The private sector's use of entities called pharmacy 
benefit managers for controlling drug expenditures may be instructive 
for Medicare, but the program's unique role and nature may moderate how 
these strategies will be used and the potential efficiency gains 
afforded in attempting to transfer these strategies to Medicare.
Outlook Worsening for Medicare's Long-Term Sustainability
    Today the Medicare program faces a long-range and fundamental 
financing problem driven by known demographic trends and projected 
escalation of health care spending beyond general inflation. The lack 
of an immediate crisis in Medicare financing affects the nature of the 
challenge, but it does not eliminate the need for change. Within the 
next 10 years, the first baby boomers will begin to retire, putting 
increasing pressure on the Federal budget. From the perspectives of the 
program, the Federal budget, and the economy, Medicare in its present 
form is not sustainable. Acting sooner rather than later would allow 
changes to be phased in so that the individuals who are most likely to 
be affected, namely younger and future workers, will have time to 
adjust their retirement planning while helping to avoid related 
``expectation gaps.'' Since there is considerable confusion about 
Medicare's current financing arrangements, I would like to begin by 
describing the nature, timing, and extent of the financing problem.

Demographic Trends and Expected Rise in Health Care Costs Drive 
        Medicare's Long-Term Financing Problem

    As you know, Medicare consists of two parts--HI and SMI. HI, which 
pays for inpatient hospital stays, skilled nursing care, hospice, and 
certain home health services, is financed by a payroll tax. Like Social 
Security, HI has always been largely a pay-as-you-go system. SMI, which 
pays for physician and outpatient hospital services, diagnostic tests, 
and certain other medical services, is financed by a combination of 
general revenues and beneficiary premiums. Beneficiary premiums pay for 
about one-fourth of SMI benefits, with the remainder financed by 
general revenues. These complex financing arrangements mean that 
current workers' taxes primarily pay for current retirees' benefits 
except for those financed by SMI premiums.\5\
---------------------------------------------------------------------------
    \5\ Another small source of funding derives from the tax treatment 
of Social Security benefits. Under certain circumstances, up to 85 
percent of an individual's or couple's Social Security benefits are 
subject to income taxes. Under present law, the Old-Age and Survivors 
Insurance (OASI) and Disability Insurance (DI) Trust Funds are credited 
with the income taxes attributable to the taxation of the first 50 
percent of OASDI benefit payments. The remainder of the income taxes 
attributable to the taxation of up to 85 percent of OASDI benefit 
payments is credited to the HI Trust Fund. Any other income taxes paid 
by retirees would also help finance the general revenue contribution to 
SMI.
---------------------------------------------------------------------------
    As a result, the relative numbers of workers and beneficiaries have 
a major impact on Medicare's financing. The ratio, however, is 
changing. In the future, relatively fewer workers will be available to 
shoulder Medicare's financial burden. In 2002 there were 4.9 working-
age persons (18 to 64 years) per elderly person, but by 2030, this 
ratio is projected to decline to 2.8. For the HI portion of Medicare, 
in 2002 there were nearly 4 covered workers per HI beneficiary. Under 
their intermediate 2003 estimates, the Medicare trustees project that 
by 2030 there will be only 2.4 covered workers per HI beneficiary. (See 
fig. 1.)

        Figure 1.--Ratio of HI-Covered Workers to Beneficiaries

[GRAPHIC] [TIFF OMITTED] T9405A.005

    Source: CMS, Office of the Actuary.
    Note: Projections based on the intermediate assumptions of The 2003 
Annual Report of the Boards of Trustees of the Federal Hospital 
Insurance and Federal Supplementary Medical Insurance Trust Funds.

    The demographic challenge facing the system has several causes. 
People are retiring early and living longer. As the baby boom 
generation ages, the share of the population age 65 and over will 
escalate rapidly. A falling fertility rate is the other principal 
factor underlying the growth in the elderly's share of the population. 
In the 1960s, the fertility rate was an average of 3 children per 
woman. Today it is a little over 2, and by 2030 it is expected to fall 
to 1.95--a rate that is below replacement. The combination of the aging 
of the baby boom generation, increased longevity, and a lower fertility 
rate will drive the elderly as a share of total population from today's 
12 percent to almost 20 percent in 2030.
    Taken together, these trends threaten both the financial solvency 
and fiscal sustainability of this important program. Labor force growth 
will continue to decline and by 2025 is expected to be less than a 
third of what it is today. (See fig. 2.) Relatively fewer workers will 
be available to produce the goods and services that all will consume. 
Without a major increase in productivity, low labor force growth will 
lead to slower growth in the economy and slower growth of Federal 
revenues. This in turn will only accentuate the overall pressure on the 
Federal budget. This slowing labor force growth is not always 
recognized as part of the Medicare debate, but it is expected to affect 
the ability of the Federal budget and the economy to sustain Medicare's 
projected spending in the coming years.

                     Figure 2.--Labor Force Growth

[GRAPHIC] [TIFF OMITTED] T9405A.006

    Source: Social Security Administration, Office of the Chief 
Actuary, and GAO.
    Note: GAO analysis based on the intermediate assumptions of The 
2003 Annual Report of the Board of Trustees of the Federal Old-Age and 
Survivors Insurance and the Federal Disability Insurance Trust Funds. 
Percentage change is calculated as a centered 5-year moving average.

    The demographic trends I have described will affect both Medicare 
and Social Security, but Medicare presents a much greater, more 
complex, and more urgent challenge. Unlike Social Security, Medicare 
spending growth rates reflect not only a burgeoning beneficiary 
population, but also the escalation of health care costs at rates well 
exceeding general rates of inflation. The growth of medical technology 
has contributed to increases in the number and quality of health care 
services. Moreover, the actual costs of health care consumption are not 
transparent. Third-party payers largely insulate covered consumers from 
the cost of health care decisions. These factors and others contribute 
to making Medicare a greater and more complex fiscal challenge than 
Social Security.

LHI's Trust Fund Faces Cash Flow Problems Long Before the HI Trust Fund 
        Is Projected to Be Insolvent
    Current projections of future HI income and outlays illustrate the 
timing and severity of Medicare's fiscal challenge. Today, the HI Trust 
Fund takes in more in taxes than it spends. Largely because of the 
known demographic trends I have described, this situation will change. 
Under the trustees' 2003 intermediate assumptions, program outlays are 
expected to begin to exceed program tax revenues in 2013. (See fig. 3.) 
To finance these cash deficits, HI will need to draw on the special-
issue Treasury securities acquired during the years of cash surpluses. 
For HI to ``redeem'' its securities, the government will need to obtain 
cash through some combination of increased taxes, spending cuts, and/or 
increased borrowing from the public (or, if the unified budget is in 
surplus, less debt reduction than would otherwise have been the case). 
Neither the decline in the cash surpluses nor the cash deficits will 
affect the payment of benefits, but the negative cash flow will place 
increased pressure on the Federal budget to raise the resources 
necessary to meet the program's ongoing costs. This pressure will only 
increase when Social Security also experiences negative cash flow and 
joins HI as a net claimant on the rest of the budget.\6\
---------------------------------------------------------------------------
    \6\ Under the trustees' intermediate 2003 projections, this will 
occur for Social Security (OASDI) in 2018.
---------------------------------------------------------------------------
Figure 3.--Medicare's HI Trust Fund Faces Cash Deficits as Baby Boomers 
                                 Retire

[GRAPHIC] [TIFF OMITTED] T9405A.007

    Source: CMS, Office of the Actuary and GAO.
    Note: GAO analysis based on the intermediate assumptions of The 
2003 Annual Report of the Boards of Trustees of the Federal Hospital 
Insurance and Federal Supplementary Medical Insurance Trust Funds.

    The gap between HI income and costs shows the severity of HI's 
financing problem over the longer term. This gap can also be expressed 
relative to taxable payroll (the HI Trust Fund's funding base) over a 
75-year period. This year, under the trustees' 2003 intermediate 
estimates, the 75-year actuarial deficit is projected to be 2.40 
percent of taxable payroll--a significant increase from last year's 
projected deficit of 2.02 percent. This means that to bring the HI 
Trust Fund into balance over the 75-year period, either program outlays 
would have to be immediately reduced by 42 percent or program income 
immediately increased by 71 percent, or some combination of the two. 
These estimates of what it would take to achieve 75-year trust fund 
solvency understate the extent of the problem because the program's 
financial imbalance gets worse in the 76th and subsequent years. As 
each year passes, we drop a positive year and add a much bigger deficit 
year.
    The projected exhaustion date of the HI Trust Fund is a commonly 
used indicator of HI's financial condition. Under the trustees' 2003 
intermediate estimates, the HI Trust Fund is projected to exhaust its 
assets in 2026. This solvency indicator provides information about HI's 
financial condition, but it is not an adequate measure of Medicare's 
sustainability for several reasons. In fact, the solvency measure can 
be misleading and can serve to give a false sense of security as to 
Medicare's true financial condition. Specifically, HI Trust Fund 
balances do not provide meaningful information on the government's 
fiscal capacity to pay benefits when program cash inflows fall below 
program outlays. As I have described, the government would need to come 
up with cash from other sources to pay for benefits once outlays 
exceeded program tax income.
    In addition, the HI Trust Fund measure provides no information on 
SMI. SMI's expenditures, which currently account for about 43 percent 
of total Medicare spending, are projected to grow even faster than 
those of HI in the near future. Moreover, Medicare's complex structure 
and financing arrangements mean that a shift of expenditures from HI to 
SMI can extend the solvency of the HI Trust Fund, creating the 
appearance of an improvement in the program's financial condition. For 
example, the Balanced Budget Act of 1997 modified the home health 
benefit, which resulted in shifting a portion of home health spending 
from the HI Trust Fund to SMI. Although this shift extended HI Trust 
Fund solvency, it increased the draw on general revenues and 
beneficiary SMI premiums while generating little net savings.
    Ultimately, the critical question is not how much a trust fund has 
in assets, but whether the government as a whole and the economy can 
afford the promised benefits now and in the future and at what cost to 
other claims on available resources. To better monitor and communicate 
changes in future total program spending, new measures of Medicare's 
sustainability are needed. As program changes are made, a continued 
need will exist for measures of program sustainability that can signal 
potential future fiscal imbalance. Such measures might include the 
percentage of program funding provided by general revenues, the 
percentage of total Federal revenues or gross domestic product (GDP) 
devoted to Medicare, or program spending per enrollee. As such measures 
are developed, questions would need to be asked about actions to be 
taken if projections showed that program expenditures would exceed the 
chosen level.

Absent Reform of Medicare and Other Entitlements for the Elderly, 
        Budgetary Flexibility Will Disappear
    Taken together, Medicare's HI and SMI expenditures are expected to 
increase dramatically, rising from about 12 percent of Federal revenues 
in 2002 to more than one-quarter by midcentury. The budgetary challenge 
posed by the growth in Medicare becomes even more significant in 
combination with the expected growth in Medicaid and Social Security 
spending. As shown in figure 4, Medicare, Medicaid, and Social Security 
have already grown from 13 percent of Federal spending in 1962 before 
Medicare and Medicaid were created to 42 percent in 2002.

 Figure 4.--Composition of Federal Spending by Budget Function, 1962, 
                             1982, and 2002

[GRAPHIC] [TIFF OMITTED] T9405A.008

    Source: CMS, Office of the Actuary and GAO.

    This growth in spending on Federal entitlements for retirees will 
become increasingly unsustainable over the longer term, compounding an 
ongoing decline in budgetary flexibility. Over the past few decades, 
spending on mandatory programs has consumed an ever-increasing share of 
the Federal budget.\7\ In 1962, prior to the creation of the Medicare 
and Medicaid programs, spending for mandatory programs plus net 
interest accounted for about 32 percent of total Federal spending. By 
2002, this share had almost doubled to approximately 63 percent of the 
budget. (See fig. 5.)
---------------------------------------------------------------------------
    \7\ ``Mandatory spending'' refers to outlays for entitlement 
programs such as food stamps, Medicare, and veterans' pensions; payment 
of interest on the public debt; and outlays for certain nonentitlement 
programs such as payments to States from Forest Service receipts. In 
2002 Social Security, Medicare, and Medicaid accounted for over 71 
percent of mandatory spending.
---------------------------------------------------------------------------
 Figure 5.--Federal Spending for Mandatory and Discretionary Programs, 
                   Fiscal Years 1962, 1982, and 2002

[GRAPHIC] [TIFF OMITTED] T9405A.009

    In much of the past decade, reductions in defense spending helped 
accommodate the growth in these entitlement programs. However, even 
before the terrorist attacks of September 11, 2001, this ceased to be a 
viable option. Indeed, spending on defense and homeland security will 
grow as we seek to combat new threats to our nation's security.
    GAO prepares long-term budget simulations that seek to illustrate 
the likely fiscal consequences of the coming demographic tidal wave and 
rising health care costs. These simulations continue to show that to 
move into the future with no changes in Federal retirement and health 
programs is to envision a very different role for the Federal 
Government. Assuming, for example, that the tax reductions enacted in 
2001 do not sunset and discretionary spending keeps pace with the 
economy, by midcentury Federal revenues may not even be adequate to pay 
Social Security and interest on the Federal debt. Spending for the 
current Medicare program--without any additional new benefits--is 
projected to account for more than one-quarter of all Federal revenues. 
To obtain budget balance, massive spending cuts, tax increases, or some 
combination of the two would be necessary. (See fig. 6.) Neither 
slowing the growth of discretionary spending nor allowing the tax 
reductions to sunset eliminates the imbalance. In addition, while 
additional economic growth would help ease our burden, the projected 
fiscal gap is too great for us to grow our way out of the problem.

     Figure 6.--Composition of Spending as a Share of GDP Assuming 
Discretionary Spending Grows With GDP After 2003 and the 2001 Tax Cuts 
                             Do Not Sunset

[GRAPHIC] [TIFF OMITTED] T9405A.010

    Source: GAO's March 2003 analysis.
    Note: Assumes currently scheduled Social Security benefits are paid 
in full throughout the simulation period. Social Security and Medicare 
projections are based on the trustees' 2003 intermediate assumptions.

    Indeed, long-term budgetary flexibility is about more than Social 
Security and Medicare. While these programs dominate the long-term 
outlook, they are not the only Federal programs or activities that bind 
the future. The Federal Government undertakes a wide range of programs, 
responsibilities, and activities that obligate it to future spending or 
create an expectation for spending. A recent GAO report describes the 
range and measurement of such fiscal exposures--from explicit 
liabilities such as environmental cleanup requirements to the more 
implicit obligations presented by life-cycle costs of capital 
acquisition or disaster assistance.\8\ Making government fit the 
challenges of the future will require not only dealing with the 
drivers--such as entitlements for the elderly--but also looking at the 
range of other Federal activities. A fundamental review of what the 
Federal Government does and how it does it will be needed. This 
involves looking at the base of all major spending and tax policies to 
assess their appropriateness, priority, affordability, and 
sustainability in the years ahead.
---------------------------------------------------------------------------
    \8\ U.S. General Accounting Office, Fiscal Exposures: Improving the 
Budgetary Focus on Long-Term Costs and Uncertainties, GAO-03-213 
(Washington, D.C.: Jan. 24, 2003).
---------------------------------------------------------------------------
Medicare Is Projected to Absorb Ever-Increasing Shares of the Economy
    At the same time, it is important to look beyond the Federal budget 
to the economy as a whole. Figure 7 shows the total future draw on the 
economy represented by Medicare, Medicaid, and Social Security. Under 
the 2003 trustees' intermediate estimates and the Congressional Budget 
Office's (CBO) most recent long-term Medicaid estimates, spending for 
these entitlement programs combined will grow to 14 percent of GDP in 
2030 from today's 8.4 percent. Taken together, Social Security, 
Medicare, and Medicaid represent an unsustainable burden on future 
generations.

    Figure 7: Social Security, Medicare, and Medicaid Spending as a 
                           Percentage of GDP

[GRAPHIC] [TIFF OMITTED] T9405A.011


    Source: CMS, Office of the Actuary, SSA, Office of the Chief 
Actuary, CBO, and GAO.
    Note: Projections based on the intermediate assumptions of the 2003 
trustees' Reports, CBO's March 2003 short-term Medicaid estimates, and 
CBO's June 2002 Medicaid long-term projections under midrange 
assumptions.

    Although real incomes are projected to continue to rise, they are 
expected to grow more slowly than has historically been the case. At 
the same time, the demographic trends and projected rates of growth in 
health care spending I have described will mean rapid growth in 
entitlement spending. Taken together, these projections raise serious 
questions about the capacity of the relatively smaller number of future 
workers to absorb the rapidly escalating costs of these programs.
    As HI Trust Fund assets are redeemed to pay Medicare benefits and 
SMI expenditures continue to grow, the program will constitute a claim 
on real resources in the future. As a result, taking action now to 
increase the future pool of resources is important. To echo Federal 
Reserve Chairman Alan Greenspan, the crucial issue of saving in our 
economy relates to our ability to build an adequate capital stock to 
produce enough goods and services in the future to accommodate both 
retirees and workers in the future.\9\ The most direct way the Federal 
Government can raise national saving is by increasing government 
saving; that is, as the economy returns to a higher growth path, a 
balanced fiscal policy that recognizes our long-term challenges can 
help provide a strong foundation for economic growth and can enhance 
our future budgetary flexibility. It is my hope that we will think 
about the unprecedented challenge facing future generations in our 
aging society. Putting Medicare on a sustainable path for the future 
would help fulfill this generation's stewardship responsibility to 
succeeding generations. It would also help to preserve some capacity 
for future generations to make their own choices for what role they 
want the Federal Government to play.
---------------------------------------------------------------------------
    \9\ Testimony before the Senate Committee on Banking, Housing, and 
Urban Affairs, July 24, 2001.
---------------------------------------------------------------------------
    As with Social Security, both sustainability and solvency 
considerations drive us to address Medicare's fiscal challenges sooner 
rather than later. HI Trust Fund exhaustion may be more than 20 years 
away, but the squeeze on the Federal budget will begin as the baby boom 
generation begins to retire. This will begin as early as 2008, when the 
leading edge of the baby boom generation becomes eligible for early 
retirement.\10\ CBO's current 10-year budget and economic outlook 
reflects this. CBO projects that economic growth will slow from an 
average of 3.2 percent a year from 2005 through 2008 to 2.7 percent 
from 2009 through 2013, reflecting slower labor force growth. At the 
same time, annual rates of growth in entitlement spending will begin to 
rise. Annual growth in Social Security outlays is projected to 
accelerate from 5.2 percent in 2007 to 6.6 percent in 2013. Annual 
growth in Medicare enrollees is expected to accelerate from 1.1 percent 
today to 2.9 percent in 2013. Acting sooner rather than later is 
essential to ease future fiscal pressures and also provide a more 
reasonable planning horizon for future retirees. We are now at a 
critical juncture. In less than a decade, the profound demographic 
shift that is a certainty will have begun.
---------------------------------------------------------------------------
    \10\ In 2008, the first baby boomers will reach age 62 and become 
eligible for Social Security benefits; in 2011, they will reach age 65 
and become eligible for Medicare benefits.
---------------------------------------------------------------------------
As Bleak Fiscal Future Looms, Efforts to Address Medicare Coverage 
        Gaps Are Being Considered
    Despite a common awareness of Medicare's current and future fiscal 
plight, pressure has been building to address recognized gaps in 
Medicare coverage, especially the lack of a prescription drug benefit 
and protection against financially devastating medical costs. Filling 
these gaps could add significant expenses to an already fiscally 
overburdened program. Under the trustees' 2003 intermediate 
assumptions, the present value of HI's actuarial deficit is $6.2 
trillion, a 20-percent increase from the prior year.\11\ This difficult 
situation argues for tackling the greatest needs first and for making 
any benefit additions part of a larger structural reform effort.
---------------------------------------------------------------------------
    \11\ This estimate represents the present value of HI's future 
expenditures less future tax income, taking into account the amount of 
HI Trust Fund assets at hand at the beginning of the projection period 
and adjusting for the ending target trust fund balance. Excluding the 
ending target trust fund balance, HI's unfunded obligation is estimated 
to be $5.9 trillion over the 75-year period under the trustees' 2003 
intermediate assumptions.
---------------------------------------------------------------------------
    The Medicare benefit package, largely designed in 1965, provides 
virtually no outpatient drug coverage. Beneficiaries may fill this 
coverage gap in various ways. According to the Medicare Current 
Beneficiary Survey, nearly two-thirds of Medicare beneficiaries had 
some form of drug coverage from a supplemental insurance policy, health 
plan, or public program at some point during 1999. All beneficiaries 
have the option to purchase supplemental policies--Medigap--when they 
first become eligible for Medicare at age 65. Those policies that 
include drug coverage tend to be expensive and provide only limited 
benefits. Some beneficiaries have access to coverage through employer-
sponsored policies or private health plans that contract to serve 
Medicare beneficiaries. In recent years, coverage through these sources 
has become more expensive and less widely available. Beneficiaries 
whose incomes fall below certain thresholds may qualify for Medicaid or 
other public programs. More than one-third may lack drug coverage 
altogether.
    In recent years, prescription drug expenditures have grown 
substantially, both in total and as a share of all heath care outlays. 
Prescription drug spending grew an average of 15.9 percent per year 
from 1996 to 2001, more than double the 6.5 percent average growth rate 
for health care expenditures overall. (See table 1.) As a result, 
prescription drugs account for a growing share of health care spending, 
rising from 6.5 percent in 1996 to 9.9 percent in 2001. By 2012, 
prescription drug expenditures are expected to account for almost 15 
percent of total health expenditures.


              Table 1.--National Expenditures for Prescription Drugs and Health Care, 1996 to 2001
----------------------------------------------------------------------------------------------------------------
                                                                          Annual Growth In     Annual Growth In
                                                     Prescription Drug   Prescription Drug       Health Care
                         Year                        Expenditures (in    Expenditures From    Expenditures From
                                                        billions)          Previous Year        Previous Year
                                                                             (percent)            (percent)
----------------------------------------------------------------------------------------------------------------
2001                                                           $140.6                 15.4                  8.7
----------------------------------------------------------------------------------------------------------------
2000                                                            121.8                 17.3                  6.9
----------------------------------------------------------------------------------------------------------------
1999                                                            103.9                 19.2                  5.7
----------------------------------------------------------------------------------------------------------------
1998                                                             87.2                 15.1                  5.4
----------------------------------------------------------------------------------------------------------------
1997                                                             75.7                 12.8                  4.9
----------------------------------------------------------------------------------------------------------------
1996                                                             67.2                 10.5                  5.0
----------------------------------------------------------------------------------------------------------------
Average annual growth from
  1996 through 2001                                                                   15.9                  6.5
----------------------------------------------------------------------------------------------------------------
Source: CMS, Office of the Actuary.


    In 2002, CBO projected that the average Medicare beneficiary would 
use $2,440 worth of prescription drugs in 2003. This is a substantial 
amount considering that some beneficiaries lack any drug coverage and 
others may have less coverage than in previous years. Moreover, 
significant numbers of beneficiaries have drug expenses much higher 
than those of the average beneficiary. CBO also estimated that, in 
2005, 12 percent of Medicare beneficiaries would have expenditures 
above $6,000.
    In focusing on the need for prescription drug coverage, we should 
not forget that Medicare does not provide complete protection from 
catastrophic losses. Under Medicare, beneficiaries have no limit on 
their out-of-pocket costs attributable to cost sharing. The average 
beneficiary who obtained services had a total liability for Medicare-
covered services of $1,700, consisting of $1,154 in Medicare copayments 
and deductibles in addition to the $546 in annual Part B premiums in 
1999, the most recent year for which data are available on the 
distribution of these costs. For beneficiaries with extensive health 
care needs, the burden can be much higher. In 1999, about 1 million 
beneficiaries were liable for more than $5,000, and about 260,000 were 
liable for more than $10,000 for covered services. In contrast, 
employer-sponsored health plans for active workers typically limited 
maximum annual out-of-pocket costs for covered services to less than 
$2,000 per year for single coverage.\12\
---------------------------------------------------------------------------
    \12\ The Kaiser Family Foundation and Health Research and Education 
Trust, Employer Health Benefits: 2000 Annual Survey (Menlo Park, Calif. 
and Chicago: 2000).
---------------------------------------------------------------------------
    Recently, several proposals have been made to add a prescription 
drug benefit to the Medicare program. While different in scope and 
detail, the proposals have certain features in common--including use of 
a third-party entity to administer the new drug benefit. The remainder 
of my remarks will focus on the lessons learned from our work regarding 
the private sector's use of such an entity to manage the drug benefits 
of insurers' policyholders and health plans' enrollees.

Private Sector Strategies for Controlling Drug Expenditures May Be 
        Instructive for Medicare
    Some proposals to add a Medicare outpatient prescription drug 
benefit look to private sector strategies as a means to administer a 
drug benefit and control costs. Most employer-sponsored health plans 
contract with private entities, known as pharmacy benefit managers 
(PBM), to administer their prescription drug benefits, and those that 
do not contract with PBMs may have units in their organizations that 
serve the same administrative purpose. Typically, on behalf of the 
health plans, PBMs negotiate drug prices with pharmacies, negotiate 
rebates with drug manufacturers, process drug claims, operate mail-
order pharmacies, and employ various cost-control techniques, such as 
formulary management and drug utilization reviews. In 2001, nearly 200 
million Americans had their prescription drug benefits administered 
through PBMs. This year, we reported on the use of PBMs by health plans 
in the Federal Employees' Health Benefits Program (FEHBP).\13\ In 
considering the application of these findings to Medicare, we are 
reminded that Medicare's unique role and nature may temper how the 
strategies and potential efficiency gains afforded by private sector 
PBMs may be transferred to benefit the program.
---------------------------------------------------------------------------
    \13\ U.S. General Accounting Office, Federal Employees' Health 
Benefits: Effects of Using Pharmacy Benefit Managers on Health Plans, 
Enrollees, and Pharmacies, GAO-03-196 (Washington, D.C.: Jan. 10, 
2003). FEHBP covered about 8.3 million Federal employees, retirees, and 
their dependents as of July 2002, and the three FEHBP plans we reviewed 
accounted for about 55 percent of FEHBP enrollment. The FEHBP plans and 
PBMs we reviewed were Blue Cross and Blue Shield, which contracted with 
AdvancePCS for retail pharmacy services and Medco Health Solutions for 
mail-order services; Government Employees Hospital Association, which 
contracted with Medco Health Solutions; and PacifiCare of California, 
which contracted with Prescription Solutions, another subsidiary of 
PacifiCare Health Systems.
---------------------------------------------------------------------------
Private Sector Uses PBMs to Leverage Price Negotiations through Volume 
        Purchasing
    PBMs use purchasing volume to leverage their negotiations with 
pharmacies and drug manufacturers in seeking favorable prices in the 
form of discounts, rebates, or other advantages. Through negotiations, 
PBMs create networks of participating retail pharmacies, promising the 
pharmacies a greater volume of customers in exchange for discounted 
prices. PBMs may be able to secure larger discounts by limiting the 
number of network pharmacies. However, smaller networks provide 
beneficiaries fewer choices of retailers, thereby limiting convenient 
access. These are trade-offs health plans must consider in deciding how 
extensive a pharmacy network they want their PBMs to offer 
beneficiaries. The health plans we reviewed in our FEHBP study 
generally provided broad retail pharmacy networks. The average 
discounted prices PBMs obtained for drugs from retail pharmacies were 
about 18 percent below the average prices cash-paying customers without 
drug coverage would have paid for 14 selected widely used brand-name 
drugs. For 4 selected generic drugs, the PBM-negotiated retail pharmacy 
prices were 47 percent below the price paid by cash-paying customers.
    PBMs also use their leverage to negotiate with drug manufacturers 
for rebates. Rebates generally depend on the volume of a manufacturer's 
products purchased. Health plans and PBMs can add to that volume by 
concentrating beneficiaries' purchases for particular types of drugs 
with certain manufacturers. Health plans can steer their beneficiaries' 
purchases to specific drugs through the use of a formulary--that is, a 
list of prescription drugs that health plans encourage physicians to 
prescribe and beneficiaries to use. Determining whether a drug should 
be on the formulary involves clinical evaluations based on a drug's 
safety and effectiveness, and decisions on whether several drugs are 
therapeutically equivalent.\14\ Restricting the formulary to fewer 
drugs within a therapeutic class can provide the PBMs with greater 
leverage in negotiating higher rebates because they can help increase 
the manufacturer's market share for certain drugs. However, a 
restricted formulary provides beneficiaries with fewer preferred drug 
alternatives and makes the policies governing coverage of nonformulary 
drugs or the cost sharing for them critical to beneficiaries.\15\
---------------------------------------------------------------------------
    \14\ A pharmacy and therapeutics committee within the health plan 
or a PBM typically makes decisions about whether to include particular 
brand-name or generic drugs on the plan's formulary.
    \15\ Plans generally encourage the use of formulary drugs by having 
lower cost sharing or requiring special approval of a nonformulary 
drug. For example, health plans have increasingly adopted three-tiered 
cost-sharing strategies whereby enrollees incur the lowest out-of-
pocket costs for using generic drugs, higher costs for brand-name drugs 
on the formulary, and the highest costs for brand-name drugs not 
included on the formulary.
---------------------------------------------------------------------------
    The FEHBP plans and PBMs we reviewed provided enrollees with 
generally nonrestrictive drug formularies across a broad range of drugs 
and therapeutic categories.\16\ The manufacturer rebates that the PBMs 
passed through to the FEHBP plans effectively reduced plans' annual 
spending on prescription drugs by a range of 3 percent to 9 percent. 
The share of rebates PBMs passed through to the FEHBP plans varied 
subject to contractual agreements negotiated between the plans and the 
PBMs.
---------------------------------------------------------------------------
    \16\ Our report compared the FEHBP plans' formularies to the 
Department of Veterans Affairs (VA) National Formulary, considered by 
the Institute of Medicine to be not overly restrictive. Each FEHBP plan 
we reviewed included over 90 percent of the drugs listed on the VA 
formulary or therapeutically equivalent alternatives, and included at 
least one drug in 93 percent to 98 percent of the therapeutic classes 
covered by VA.
---------------------------------------------------------------------------
    PBMs also assisted the FEHBP plans by providing a less expensive 
mail-order drug option. Mail-order prices for the FEHBP plans we 
reviewed averaged about 27 percent lower than cash-paying customers 
would pay for the same quantity at retail pharmacies for 14 brand-name 
drugs and 53 percent lower for 4 generic drugs. The FEHBP plans 
generally had lower cost-sharing requirements for drugs purchased 
through mail order, particularly for more expensive brand-name drugs or 
maintenance medications for chronic conditions.
    The claims and information processing capabilities PBMs offered 
also helped the FEHBP plans to manage drug costs and monitor quality of 
care. PBMs maintain a centralized database on each enrollee's drug 
history that can be used to review for potential adverse drug 
interactions or potentially less expensive alternative medications. 
They also use claims data to monitor patterns of patient use, physician 
prescribing practices, and pharmacy dispensing practices. Their systems 
provide ``real-time'' claims adjudication capabilities that allow a 
customer's claim for a drug purchase to be approved or denied at the 
time the pharmacist begins the process of filling a prescription. Two 
plans in our FEHBP study reported savings ranging from 6 to 9 percent 
of the plan's annual drug spending; the savings were associated 
primarily with real-time claims denials preventing early drug refills 
and safety advisories cautioning pharmacists about potential adverse 
interactions or therapy duplications.

Use of Private-Sector Strategies in Medicare Would Represent Departure 
        from Traditional Policies and Practices
    While Medicare's sheer size would provide it with significant 
leverage in negotiating with pharmacies and drug manufacturers, doing 
so would represent a departure from traditional Medicare. Medicare 
beneficiaries represent less than 15 percent of the population but a 
disproportionately higher share--about 40 percent--of prescription drug 
spending. However, because of Medicare's design and obligations as a 
public program, its current purchasing strategies vary considerably 
from those of the private sector.

       Any willing provider. In contrast with private payers' 
reliance on selective contracting with providers and suppliers, the 
traditional Medicare program has generally allowed any hospital, 
physician, or other provider willing to accept Medicare's 
reimbursements and requirements to participate in the program. With 
respect to drug purchasing in particular, private plans determine the 
extent of their enrollees' access by the choices they make about the 
size of their participating pharmacy network and breadth of their drug 
formulary. Allowing any pharmacy willing to meet Medicare's terms to 
participate or allowing all therapeutically equivalent drugs equal 
coverage on a formulary would restrict the program's ability to secure 
advantageous prices. Moreover, health plans and PBMs currently make 
formulary determinations privately. In contrast, Medicare's policies 
have historically been open to public comment.
       Administrative rate-setting. Whereas private health 
plans typically rely on price negotiations to establish payment rates, 
Medicare generally establishes payment rates administratively. As 
discussed earlier, Medicare's rates often exceed market prices and this 
is the case for some of the few outpatient prescription drugs covered 
by Medicare.\17\ The program's method of paying for these drugs is 
prescribed in statute: In essence, Medicare pays 95 percent of a drug's 
``average wholesale price'' (AWP). Despite its name, however, AWP is 
not necessarily a price that wholesalers charge and is not based on the 
price of any actual sale of drugs by a manufacturer. AWPs are published 
by manufacturers in drug price compendia, and Medicare bases providers' 
payments on these published AWPs. Other public and private purchasers 
typically use the leverage of volume and competition to secure better 
prices. By statute, Medicaid, the nation's health insurance program for 
certain low-income Americans, is guaranteed manufacturers' rebates 
based on prices charged other purchasers.\18\ Certain other public 
payers can pay at rates set in the Federal supply schedule, which uses 
verifiable confidential information on the prices drug manufacturers 
charge their ``most favored'' private customers. Manufacturers agree to 
these prices, in part, in exchange for the right to sell drugs to the 
more than 40 million Medicaid beneficiaries.
---------------------------------------------------------------------------
    \17\ GAO-01-1118.
    \18\ Since the enactment of the Omnibus Budget Reconciliation Act 
of 1990, drug manufacturers are required to provide rebates to State 
Medicaid programs on outpatient drugs based on the ``lowest'' or 
``best'' prices they charged other purchasers or a minimum of 15.1 
percent of the average manufacturers' price (AMP) for brand-name drugs. 
Rebates must be at least 11 percent of AMP for generic drugs.
---------------------------------------------------------------------------
       Low-budget program administration. Duplicating the type 
of controls PBMs have exercised over private-sector drug benefits would 
likely involve devoting a larger share of total expenditures to 
administration than is spent by Medicare currently. Medicare's 
administrative costs historically have been extremely low, averaging 
about 2 percent of the cost of the services themselves.\19\ This level 
of expenditure may not be consistent with the level needed to review 
the volumes of claims data associated with prescription drugs for the 
elderly or acquire and maintain the on-line systems and databases PBMs 
use to employ such utilization controls as real-time claims 
adjudication. The number of prescriptions for Medicare beneficiaries 
could easily exceed the current number of claims for all other services 
combined, or over 1 billion annually.
---------------------------------------------------------------------------
    \19\ U.S. General Accounting Office, Medicare: HCFA Faces 
Challenges to Control Improper Payments, GAO/T-HEHS-00-74, (Washington, 
D.C.: Mar. 9, 2000).
---------------------------------------------------------------------------

Decisions about the Extent of Latitude and Competition Allowed Are 
        Critical to Administering a Medicare Drug Benefit
    Medicare would undoubtedly need assistance from external entities 
to administer a drug benefit, just as it has used insurers to process 
claims in the traditional program and Medicare+Choice plans to go 
further by also managing services and assuming risk. Decisions about 
the roles assigned an entity or entities and the latitude allowed them 
in carrying out those roles would be critical. These decisions would 
undoubtedly affect the benefit's value to beneficiaries and the 
efficiencies and savings secured for both beneficiaries and taxpayers. 
Some of these decisions parallel those made by FEHBP plans that I 
discussed--trade-offs about beneficiaries' interests in broad pharmacy 
networks and formularies versus potential savings. Others stem from the 
uniqueness of Medicare, its likely disproportionate share of the drug 
market, and its position as a public program requiring transparency and 
fairness.
    Insurers and PBMs have been successful in securing some savings on 
drug purchases by leveraging their volume to move market share from one 
product to another. Medicare's leverage, given that purchases by the 
elderly constitute about 40 percent of the drug market, could be 
considerable. Yet the large market share may also be likely to attract 
considerable attention. The administration of a Medicare drug benefit 
could then be subject to the same intensity of external pressures from 
interested parties regarding program prices and rules that can often 
inhibit the program from operating efficiently today. The potential for 
micromanagement could compromise trying to use the very flexibility 
PBMs have employed in negotiating prices and selecting preferred 
providers in order to generate savings. An alternative would be to 
sacrifice some of the program's leverage and grant flexibility to 
multiple PBMs or similar entities so that any one entity would be 
responsible for administering only a share of the market.
    Contracting with multiple PBMs or similar entities, however, would 
pose other challenges. If each had exclusive responsibility for a 
geographic area, beneficiaries who wanted certain drugs could be 
advantaged or disadvantaged merely because they lived in a particular 
area. To minimize inequities, Medicare could, like some private sector 
purchasers, specify core benefit characteristics or maintain clinical 
control over formulary decisions instead of delegating those decisions 
to its contractors.
    If multiple PBMs or similar entities operated in a designated area, 
beneficiaries could choose among them to administer their drug 
benefits. These organizations would compete for consumers directly on 
the basis of differences in their drug benefit offerings and 
administration. This contrasts with the private sector where drug 
benefits are typically part of an overall insurance plan, and PBMs 
typically compete for contracts with insurers or other purchasers. 
Competition could be favorable to beneficiaries if they were adequately 
informed about differences among competing entities offering drug 
benefits and shared in the savings. However, adequate oversight would 
need to be in place to ensure that fair and effective competition was 
maintained. For example, a means to ensure that beneficiaries received 
comprehensive user-friendly information about policy and benefit 
differences among competing entities would be necessary. Monitoring 
marketing and customer recruitment strategies and holding entities 
accountable for complying with Federal requirements would require 
adequate investment. The contracting entities could need protections as 
well. Some mechanism would be needed to risk adjust payments for 
differences in beneficiaries' health status so that those entities 
enrolling a disproportionate share of high-use beneficiaries would not 
be disadvantaged.

Concluding Observations
    Medicare's financial challenge is very real and growing. The 21st 
century has arrived and our demographic tidal wave is on the horizon. 
Within 5 years, individuals in the vanguard of the baby boom generation 
will be eligible for Social Security and 3 years after that they will 
be eligible for Medicare. The future costs of serving the baby boomers 
are already becoming a factor in CBO's short-term cost projections.
    Frankly, we know that incorporating a prescription drug benefit 
into the existing Medicare program will add hundreds of billions of 
dollars to program spending over just the next 10 years. For this 
reason, I cannot overstate the importance of adopting meaningful 
reforms to ensure that Medicare remains viable for future generations. 
Adding a drug benefit to Medicare requires serious consideration of how 
that benefit will affect overall program spending. If competing private 
entities are to be used to administer a drug benefit, it is important 
to understand how these entities can be used in the Medicare context to 
provide a benefit that balances beneficiary needs and cost containment.
    Medicare reform would be done best with considerable lead time to 
phase in changes and before the changes that are needed become dramatic 
and disruptive. Given the size of Medicare's financial challenge, it is 
only realistic to expect that reforms intended to bring down future 
costs will have to proceed incrementally. We should begin this now, 
when retirees are still a far smaller proportion of the population than 
they will be in the future. The sooner we get started, the less 
difficult the task will be.
    We must also be mindful that health care costs compete with other 
legitimate priorities in the Federal budget, and their projected growth 
threatens to crowd out future generations' flexibility to decide which 
competing priorities will be met. In making important fiscal decisions 
for our nation, policymakers need to consider the fundamental 
differences among wants, needs, and what both individuals and our 
nation can afford. This concept applies to all major aspects of 
government, from major weapons system acquisitions to issues affecting 
domestic programs. It also points to the fiduciary and stewardship 
responsibility that we all share to ensure the sustainability of 
Medicare for current and future generations within a broader context of 
providing for other important national needs and economic growth.
    The public sector can play an important role in educating the 
nation about the limits of public support. Currently, there is a wide 
gap between what patients and providers expect and what public programs 
are able to deliver. Moreover, there is insufficient understanding 
about the terms and conditions under which health care coverage is 
actually provided by the nation's public and private payers. In this 
regard, GAO is preparing a health care framework that includes a set of 
principles to help policymakers in their efforts to assess various 
health financing reform options. This framework will examine health 
care issues systemwide and identify the interconnections between public 
programs that finance health care and the private insurance market. The 
framework can serve as a tool for defining policy goals and ensuring 
the use of consistent criteria for evaluating changes. By facilitating 
debate, the framework can encourage acceptance of changes necessary to 
put us on a path to fiscal sustainability. I fear that if we do not 
make such changes and adopt meaningful reforms, future generations will 
enjoy little flexibility to fund discretionary programs or make other 
valuable policy choices.
    Mr. Chairman, this concludes my prepared statement. I will be happy 
to answer any questions you or other Committee Members may have.
Contacts and Acknowledgments
    For future contacts regarding this testimony, please call William 
J. Scanlon, Director, Health Care Issues, at (202) 512-7114. Other 
individuals who made key contributions include Rashmi Agarwal, Linda 
Baker, John Dicken, Hannah Fein, Kathryn Linehan, James McTigue, 
Jennifer Rellick, and Melissa Wolf.

                                 

    Chairman THOMAS. I thank both of you very much.
    It has sometimes been said, notwithstanding the charts, 
that the solvency of Medicare is probably greater than in 
previous periods and that we really shouldn't worry all that 
much about it because when the pressure increases on us, 
historically we have always done something. One of the concerns 
that the Chair has is that some of the easy choices were taken 
early.
    For example, when this Committee engages--and it will--in 
discussion of Social Security and the solvency of that trust 
fund, we are all mindful that currently the payroll tax is 
capped at a particular dollar amount. The HI Trust Fund already 
does not have the cap that could be removed.
    So, notwithstanding that 2013 and 2016 still seems like 
some time away, do you believe we have luxury of arguing that 
since we probably have as great a front-loaded number of years 
of solvency as we have had at any time in the past, that that 
is a comfort that we should wait awhile over?
    Mr. WALKER. We should not focus on the trust fund balance, 
for reasons that I articulated. I think we have three basic 
sustainability problems: At the lowest level, Medicare; at the 
next level, our health care system; and at the top level, our 
overall fiscal imbalance.
    Chairman THOMAS. Well, I tell you that I feel a little bit 
about Medicare as I probably feel even more about the health 
care system, because frankly when you compare us with other 
countries--and sometimes you can't do it on an absolute base, 
you have to look at other humans in the human condition and 
what they do--it isn't so much how much we spend for health 
care in this country, and underscored as well for some of the 
government support programs like Medicare, it is how we spend 
it. One of the reasons we have been so concerned about wanting 
to try to make some fundamental modernizations or changes to 
Medicare is because without those, Medicare as a support 
structure isn't fashioned in the best way to receive a major 
prescription drug addition--something as simple as the 
historical creation of the A and the so-called B, one from a 
dedicated trust fund, the other one from the general fund; and 
the fact that it doesn't look much like an insurance policy or 
any provisions that would give us comfort that some of the 
things that we have seen work in other systems simply won't 
work here by virtue of the way it was created and the failure 
to keep it up to date.
    Throwing on a prescription drug benefit doesn't solve the 
underlying concerns over Medicare. Is that a fair statement?
    Mr. WALKER. I think it is fair to say that if the 
conditions that exist today had existed in 1965, you probably 
would have included a prescription drug benefit in Medicare to 
begin with. On the other hand, you probably also would have 
included a number of other cost-containment mechanisms that you 
do not have today. So, on one hand you are talking about adding 
a prescription drug benefit, which most employers have added 
since 1965, but they have also changed their health insurance 
coverage in many other ways, with targeting, deductibles, 
copays, and things of that nature, and Medicare has not.
    Chairman THOMAS. Let me just briefly, then, ask you some 
questions about the Medicare Payment Advisory Commission. They 
perform a very important role. We attempted to create a 
commission made up of professionals who have a broad background 
in health care touching any number of areas, along with some 
consumer advocates--who examine current conditions and make 
recommendations on assistance to various providers and other 
decisions that we need to make.
    One of the major changes that was made recently was to 
require MEDPAC, as we call it, to vote--because they have a 
chance to influence public policy, we thought it might be 
useful to require public votes so that people could see how the 
interests that may represent particular areas of health care 
voted on particular issues. I know MEDPAC recently made 17 
recommendations to the House and specifically this Committee. 
What I found most striking about those recommendations, that 
where the 17 members--I believe it was 19 recommendations--
where the 17 members made 19 recommendations, if you added up 
all the individual votes, and of course certain things happen 
in the House if it is a voice vote versus a recorded vote 
versus how many people are in opposition, we handle issues 
differently based upon the votes. When you add up all the votes 
of MEDPAC on those 19 recommendations, there were collectively 
300 ayes for the position taken, and 2 nays.
    Given the depth and breadth of the professionalism and 
history of experience of MEDPAC, should this Committee be 
impressed by, ignore--how should we deal with recommendations 
that are presented to us by that body with a vote of 300 to 2?
    Mr. WALKER. Mr. Chairman, I have tried very hard to work 
with this Committee and others as Comptroller General of the 
United States to appoint MEDPAC members. I believe that we have 
significantly upgraded MEDPAC in the last several years. I 
believe that you need to give serious consideration to the 
recommendations that you receive from MEDPAC. They are hampered 
with a problem that this Committee, GAO, and many others have 
in that they don't have an adequate amount of timely, accurate 
and useful health care information. Their basic recommendations 
are consistent with the work that GAO has done, and I think 
that you need to seriously consider their recommendations.
    I also think it was appropriate to increase the 
transparency and accountability of the votes associated with 
MEDPAC members. I think that was appropriate, given their 
substantial responsibilities and the sums involved.
    Chairman THOMAS. Have you had any feedback from the MEDPAC 
members themselves about their willingness and comfortableness 
with the transparency in the recorded votes, as a process, as 
opposed to what they used to do?
    Mr. WALKER. Well, initially there was some apprehension. I 
have not heard any concerns. I think there generally is an 
understanding that it was the right thing to do.
    Chairman THOMAS. I thank the gentlemen. Dr. Holtz-Eakin, it 
is always difficult to ask a new director of CBO about 
estimates that have been made in the past, although I assume 
you have a moral obligation to accept all of the product of 
previous CBOs and directors. Sometimes when people focus on the 
debate on the floor of the House example, with amendments or 
substitutes to bills, the discussion is couched in ways in 
which people can't fairly judge or discriminate between 
approaches taken by various bills. One of the things I hope to 
do with this hearing is to at least begin the record with a 
clear understanding that there are consequences to choices that 
are made in the way you structure bills. I know this may be 
uncomfortable for some folk, but I don't really know any other 
way to begin a process of talking about building a bill without 
asking some fairly direct questions, and asking you if you have 
the ability to compare particular structures.
    For example, included in the bill that passed the House 
last year was a provision that we called the best price policy, 
which would have required a degree of negotiation on discounts 
from pharmaceutical manufacturers without regard to an 
artificial so-called best price structure that is located in 
Medicare. I am always fearful when someone tells me they are 
going to give me the best price, especially if it is a 
structured best price.
    In looking at last year's bill--and it is true, as was 
commented, there is no bill for the majority in yet. We are 
looking at these issues and want to make some decisions. In 
comparison, the gentleman from California, for example, Mr. 
Stark, does have a bill in this year--I believe it is H.R. 
1199. Have you been able to score that bill yet, Doctor?
    Dr. HOLTZ-EAKIN. We do not yet have a score on the bill 
this year. We did, in fact, do work in previous years on these 
issues.
    Chairman THOMAS. Okay. So, we might be comparing last 
year's bills rather than the current edition.
    Did the idea of negotiating discounts save money over a 
best price--first part of the question. Second part, for 
example, a tool that was utilized, I believe, in the previous 
bill, where you allow physicians to override formularies and 
provide an any-willing-provider structure for pharmacies. Those 
are two ways to deal with pricing. Can you comment on each in a 
comparison between them?
    Dr. HOLTZ-EAKIN. With the caveat that I am new to the job 
and may have to get back to you with particular details, I can 
say a couple of things on those issues. The first is that in 
looking at incentives and outcomes on cost containment, one 
really wants to look at incentives and the opportunity to 
undertake cost containment. So, with regard to the best-price 
provision, that leads to a greater incentive to try to 
negotiate a lower price from a manufacturer, and as a result, 
CBO did in fact, score that in previous legislation as saving 
about $18 billion. We would undertake to update that estimate 
this year. I am not sure exactly what the precise number would 
be.
    With regard to physician override, that clearly limits the 
ability to control costs and to undertake the control of the 
lowest possible source of a pharmaceutical. As a result, it 
would lead to higher costs, other things being equal.
    Chairman THOMAS. One of the debates, and I am sure it will 
ensue again this year, over models that might be constructed is 
the idea of creating a catastrophic or so-called stop-loss 
structure, where there is some exposure which most people 
believe that if you have copayments or other arrangements in 
which beneficiaries share in the costs, that there might be 
some savings over the long run by decisions that are made in 
part because of out-of-pocket costs in which the beneficiary is 
not insulated from all costs associated with the cost of 
pharmaceuticals.
    We provided a structure in the last bill which created a 
stop-loss arrangement. My understanding is, again comparing two 
specific solutions to in essence the same problem, that H.R. 
1199 has a very low stop-loss structure, which might deal with 
so-called--price induction, is the phrase that is used--if you 
are dealing with, say, a $2,000 catastrophic as opposed to the 
structure that we had offered.
    What is your analysis of those different approaches to the 
question of exposure of beneficiaries to costs in an overall 
attempt to reduce the exposure to the Medicare trust fund?
    Dr. HOLTZ-EAKIN. Well, I again go back to the rules of 
thumb, which are incentive and opportunity. To the extent that 
beneficiaries have an incentive to control costs, you will get 
greater cost savings. Regarding larger subsidies, other things 
being equal, if you subsidize 90 percent of any insurance 
product versus, say, 70 percent, the larger subsidy will lead 
to a lower incentive to control costs and will lead to higher 
prices and higher spending.
    Chairman THOMAS. So, the idea of an assistance to 
individuals to shield them to any cost exposure ironically 
would wind up with an overall higher price because the so-
called incentive that was there is no incentive at all?
    Dr. HOLTZ-EAKIN. The key thing is to look comprehensively. 
To get total costs, you want to look comprehensively. So, you 
would want to look at incentives and opportunities for 
individuals as well as for providers. Focusing on the 
individual's part, having limited incentives to control costs 
will lead to higher costs and higher prices.
    Chairman THOMAS. Then the bottom line of all of this 
questioning is that last year the bill that passed the House, 
along with the modernization of prescription drug and provider 
portions, cost somewhere in the vicinity of $350 billion, I 
believe, and the bill that was purported to meet essentially 
the same argument from the minority's perspective cost what in 
last year's dollars?
    Dr. HOLTZ-EAKIN. The CBO score last year was roughly $970 
billion.
    Chairman THOMAS. So, $350 billion to $970 billion. Of 
course that is the direct result of having a catastrophic, 
which in fact does not induce the appropriate behavior and 
therefore costs more and does not have competition, such as we 
indicated in not accepting some formulaic best price but rather 
requiring actually a negotiated process to produce best price.
    These are the kinds of questions that I think are important 
to understand why bills contain certain provisions. When you 
add up all the particulars, it does produce a product that 
either brings about particular results at a cost that is 
afforded under a budget proposal, or you get something that is 
up to three times as expensive and, ironically in terms of the 
way it is built, produces cost increases rather than cost 
savings.
    With that, I want to thank both of you for what you have 
done and, obviously as we move into a more formal discussion of 
solutions, what you are going to do for us. Does the gentleman 
from New York wish to inquire?
    Mr. RANGEL. Thank you, Mr. Chairman. Let me thank both of 
you for pointing out expertly the degree and the serious nature 
of the problem. Am I to assume that both of you studied the 
House-passed bill in preparation for your testimony today?
    Dr. HOLTZ-EAKIN. I am familiar with the House-passed bill. 
I would not say that I am intimately familiar with all the 
details.
    Mr. WALKER. I am somewhat familiar with it, but I did not 
study it before today.
    Mr. RANGEL. Well, have you been privy to any draft of a 
bill that the majority intends to offer for our consideration 
at some point in time in the future?
    Dr. HOLTZ-EAKIN. We have to date not scored any particular 
bills at CBO. We have talked at the staff level in discussions 
about ideas, and no more.
    Mr. WALKER. I have not seen any proposed bill or framework 
for a bill.
    Mr. RANGEL. Do you think that professionally you could be 
of better assistance to this Committee if you had before you a 
bill as to the direction that we were going?
    Dr. HOLTZ-EAKIN. It will in the end be the Committee's 
judgement whether I am of assistance or not. I will tell you 
that, in our experience at CBO, the details of proposals do in 
fact matter a great deal, and the greater specificity of an 
actual bill allows us to give a more precise answer, without 
question.
    Mr. WALKER. Obviously if you have a specific proposal, you 
can make more targeted comments as to what the likely pros and 
cons of that proposal are.
    Mr. RANGEL. That makes a lot of sense to me. I get the 
impression from the past conduct of this Committee that we are 
seeing both of you for the last time on this subject matter.
    [Laughter.]
    Mr. RANGEL. Not having the slightest clue as to which 
direction the majority is going to take us, we may ask you, in 
an impartial way, to meet with--if we don't have a formal 
meeting, to share your opinions of whatever comes from the 
majority, wherever it comes from, so that we might be able to 
again visit with you and have a better understanding of the 
impact of the decisions that we will be making. I do hope that 
before we vote on this bill, assuming the bill comes back to 
this Committee and not go straight to the suspension calendar, 
that we would have an opportunity to discuss this further.
    Let me thank you for this meeting, Mr. Chairman.
    Chairman THOMAS. Thank the gentleman. I think you will find 
that oftentimes the most useful examination of an issue is in 
comparison with alternatives rather than examining it in some 
absolute environment, because then you have the opportunity to 
weigh real choices between real alternatives. The Chair hopes 
that as a plan is presented from the majority side that we will 
have an opportunity to examine one from the minority side as 
well.
    Does the gentleman from Illinois wish to inquire?
    Mr. CRANE. Thank you, Mr. Chairman.
    Now, Mr. Walker, I have in front of me the GAO Medicare 
Hospital Insurance Trust Fund projected deficit between 2010, 
starting roughly 2010 going on into 2040. Is that projection 
based on constant dollar value?
    Mr. WALKER. Yes, 2003 dollars. So, it is adjusted for 
inflation. It is the HI program alone. It does not include SMI.
    Mr. CRANE. The reason I ask that is I came to Congress in 
1969 and the dollar is worth about 10 cents today of what it 
was when I came here. You have a 30-year period here, and that 
30-year period would result in a $300 billion deficit. Is that 
a $300 billion probable deficit or a $3 trillion deficit?
    Mr. WALKER. No, it is a $300 billion, based upon 2003 
dollars. So, in other words----
    Mr. CRANE. I know, constant dollars.
    Mr. WALKER. That is correct.
    Mr. CRANE. Would you honestly expect that to happen?
    Mr. WALKER. Well----
    Mr. CRANE. How would you expect that to happen based on our 
performance here for the last 35 years?
    Mr. WALKER. We rely upon the trustees' assumptions as to 
what they expect inflation is going to be when we end up coming 
up with the discount factors. I think if you look in the past 
at how the trustees have done in projecting what cost will be, 
if anything, their intermediate assumptions have been low, not 
high. So, I think it is a realistic picture, and I think the 
bottom line is it shows you have a serious problem.
    Mr. CRANE. Well, I remember when we worried about billions 
and now we are talking trillions, and it will be quadrillions 
in another 30 years at the rate we are going. Governments 
always have a way of resolving those problems by just 
escalating the quantity of money out there. That is something 
that has me troubled about any of these kinds of projections, 
based upon our performance over the past generation.
    Mr. WALKER. What I would suggest, Mr. Crane, if you also 
looked at it as a percentage of the budget or as a percentage 
of the GDP, which we also presented information on, that may be 
a more useful way for you to look at it. Either way, it is a 
problem.
    Mr. CRANE. Oh, yeah. Oh, no question about it, it is a 
problem.
    I would like to also ask you, Mr. Walker, in your testimony 
you say GAO's long-term budget simulations show that absent 
meaningful entitlement reforms, demographic trends and rising 
health care spending will drive escalating Federal deficits and 
debt. Neither slowing the growth of discretionary spending nor 
allowing the 2001 tax reductions to sunset will eliminate the 
imbalance. Given these estimates, it seems that it will be 
difficult to modernize Medicare that includes prescription 
drugs. If a modest drug benefit program that costs $400 billion 
is going to be hard to create due to budget constraints, 
wouldn't a $1 trillion plan be next to impossible without 
massive tax increases, slashing other valuable Federal 
programs, cutting provider payments, and forcing seniors to pay 
large premiums and deductibles?
    Mr. WALKER. I think it is important, whether you are 
dealing on the spending side or the tax side, that you look at 
not just the 10-year costs but also the long-range 
implications, including discounted present value amounts. 
Obviously, to the extent that you are talking about adding a 
benefit that costs a lot more money, that is going to worsen 
the long-range imbalance. We look at the bottom line, what is 
the bottom line.
    Mr. CRANE. One final question I would like to put to you, 
either one or both of you, and that has to do with the 
recognizing Medicare's current benefit costs are escalating and 
to obtain ideas from CBO to slow that cost growth. The CBO 
projects that, absent any change in the law, annual spending on 
Medicare will more than double in 10 years to nearly $460 
billion. An analysis by the Centers for Medicare and Medicaid 
Services Office of the Actuary demonstrates that Medicare 
spending last year spiked dramatically. What recommendations 
have you regarding controlling costs of the current program, 
and have you examined the recent MEDPAC recommendations and 
what do you think of those?
    Dr. HOLTZ-EAKIN. Congressman, it is not CBO's role to make 
specific recommendations on how to control Medicare costs. I 
would be happy to discuss with you the implications of adopting 
any of the MEDPAC recommendations. We look forward to working 
with you on that.
    Mr. CRANE. Very good. Thank you. I yield back the balance 
of my time.
    Mr. MCCRERY. [Presiding.] Mr. Stark.
    Mr. STARK. Thank you, Mr. Chairman. I want to thank the 
witnesses. Mr. Walker, I wonder if you could comment on the 
effect on Medicare if the tax cuts were not extended and, 
instead of repealing the estate tax, we had merely gone with a 
fairly large exemption, say $3 or $4 million, as was suggested 
in an alternative plan; and that the taxes would rise as a 
share of the GDP. What kind of doomsday scenario--how would 
that change it, in effect?
    Mr. WALKER. We have done an overall budget simulation under 
several sets of assumptions. One set is the tax cut does not 
sunset; the other assumption is that it does sunset. Obviously, 
if it does sunset, then that makes the gap less in the outer 
years. At the same point in time, it does not come close to 
closing the gap. There is still a long-range problem 
irrespective of what the Congress decides to do there.
    Mr. STARK. Is the difference in those 2 scenarios about 25 
years till implosion or explosion, is that correct?
    Mr. WALKER. It makes a bigger difference when you are 
starting to deal with the 2030 to 2050 period. You know, either 
way, you have really escalating deficits, but the timing in 
which you start seeing those deficits, obviously, is different.
    Mr. STARK. Did you do any studies on the change needed in 
the--if you assumed that we did not extend the 2001 tax cut or 
the inheritance tax demise, what kind of a payroll tax increase 
would be needed to----
    Mr. WALKER. We didn't do that. We looked at the larger 
fiscal picture, which is what the long-range budget simulation 
is intended to be. Mr. Stark, the trustees' latest report for 
2003 would show that if you wanted to solve the problem merely 
through increasing the tax rate for HI, you would have to 
increase the HI tax rate by 83 percent today in order to solve 
it just through that. That would only solve it for the next 75 
years. Every year we have a big deficit beyond the 75 year 
horizon that has to be dealt with.
    Mr. STARK. Well, I might ask the same question, Dr. Holtz-
Eakin. It is my understanding that we could pass the 75 year 
solvency test--which we have never achieved, I might add--if we 
increase the payroll tax by about 1.2 percent on both sides. Is 
that a number with which you gentlemen would concur?
    Mr. WALKER. Yes, 2.4 percent of taxable payroll. You are 
correct, 1.2 percent on each side, which would be an 83-percent 
increase.
    Mr. STARK. In a sense, that would pretty much solve, given 
what we know now about the increased spending on health care, 
that would solve this problem financially speaking for all 
time.
    Mr. WALKER. No, it does not.
    Mr. STARK. Seventy-five years.
    Mr. WALKER. That solves Part A, HI, for 75 years; it 
doesn't do anything about SMI, it doesn't do anything about the 
broader health care challenge or the long-range fiscal problem.
    Mr. STARK. Okay, so that is on the HI and the Part A side. 
The worst-case scenario for 75 years, which is about as far 
ahead as we care to plan. That is fair. Now, how much would it 
take in--have you then to solve the Part B side to provide 
enough additional general revenues to cover the 75 percent that 
we fund now. If this were done, how much more than not 
extending the 2001 tax cut and not eliminating the inheritance 
tax, how much more revenue would that--My understanding, that 
this total tax cut, including the interest cost, is about a $2 
trillion loser.
    Mr. WALKER. Well, first, I think it is important----
    Mr. STARK. Is that correct?
    Mr. WALKER. I don't have the number. I can provide it for 
the record. I can tell you that--in fact CBO would probably be 
the right place to get that number, since they are the ones 
that are supposed to be doing the projections. I----
    Mr. STARK. Give it to CBO.
    Mr. WALKER. I would say for the record, though, Mr. Stark, 
that the 2.4 percent is not worst-case. That is based on the 
intermediate assumptions. The trustees have low-cost, high-
cost, and intermediate cost estimates. So, it is not worst-
case, and again, it only deals with HI, not SMI.
    Mr. MCCRERY. Before----
    Mr. STARK. Could I--Mr. Chairman, I just the indulgence to 
hear Dr. Holtz----
    Mr. MCCRERY. If Dr. Holtz-Eakin would like to answer, that 
is fine.
    Dr. HOLTZ-EAKIN. Briefly, I am not privy to the simulations 
that Mr. Walker has discussed. In the chart that I showed you, 
what we displayed was a rise in Medicare costs from about 2.5 
percent of GDP to in excess of 9 percent of GDP over the 75 
year horizon you are discussing. Those costs will have to be 
financed somehow. Spending is ultimately a burden on the 
economy. I would also point out to you that these are 
projections made under the assumption that health care costs 
rise 1 percentage point faster than GDP. Historically, Medicare 
costs have risen 2.8 percentage points faster than GDP. So, 
these projections actually contain the assumption that there 
will be steps taken to bring cost growth down. To the extent 
that that does not happen, these numbers would be, in fact, 
dramatically larger than the estimates that are in my written 
testimony. The particulars of the financing which you have been 
discussing, I would argue, are secondary to the ultimate 
observation that the outlays will rise as a fraction of the 
economic resources in this economy that are available to 
finance those programs and any others.
    Mr. MCCRERY. Dr. Holtz-Eakin, do these numbers include the 
addition of a prescription drug benefit?
    Dr. HOLTZ-EAKIN. No, they do not.
    Mr. MCCRERY. How much difference would it make if we were 
to add a $400 billion or trillion----
    Dr. HOLTZ-EAKIN. We would have to do a careful set of 
estimates. I would be happy to work with you on that. Four 
hundred billion dollars is roughly $50 billion a year over the 
8 years of the budget window in which a drug benefit would be 
in effect. That is a number that is well under 1 percent of 
GDP. However, as I pointed out in my remarks, prescription drug 
spending has been growing more rapidly than Medicare spending 
as a whole, and so the long-term outlook would certainly be 
worse, other things being equal. The precise numbers--we could 
work with you to develop an estimate.
    Mr. MCCRERY. Mr. Walker.
    Mr. WALKER. I would hope that there would be an effort to 
come up with what would be the discounted present value of what 
the cost of the program would be, not just looking at the 10-
year numbers, because they can be very misleading. I think it 
is important to look beyond that, because we don't really start 
to hit the major part of the demographic tidal wave until 
beyond the 10 year point. Therefore, you can get a false sense 
of security if you just looked at 10-year numbers. They can 
explode beyond that.
    Mr. MCCRERY. Mr. Shaw.
    Mr. SHAW. Mr. Walker, I want to go back to a point that you 
covered in your testimony. This goes back to the first graph 
that you had up there, in which you talk about Medicare going 
into a cash deficit in the year 2013. In that regard, of 
course, we have Treasury bills that are in there, and they 
won't be exhausted until what year?
    Mr. WALKER. The year 2026 is when the special issue 
Treasury securities will exhaust.
    Mr. SHAW. Does the fact that we are going through the 
process of cashing in Treasury bills, do they have any real 
economic value to the program?
    Mr. WALKER. I am not a Ph.D. economist, but I would say no, 
they don't have an economic value. They have a legal 
significance, they have a moral significance, they represent a 
priority claim on future general revenues, but they do not have 
an economic value.
    Mr. SHAW. You may not be an economist, but you are 
certainly a well-versed certified public accountant (CPA). As 
such, you certainly know the difference between a real economic 
asset and one that is not. I certainly accept your explanation. 
So, what you are talking about and what you are telling this 
Committee is that 2013 is the year in which, really, the system 
is going to have to--we are going to have to find other ways to 
pay benefits if we are going to keep taxes at their present 
level and not cut benefits. Is that correct?
    Mr. WALKER. Correct. You are either going to have to raise 
taxes, cut spending, or go into more public debt financing in 
order to convert these bonds into cash.
    Mr. SHAW. Now, the same thing applies to Social Security, 
doesn't it? What year is that?
    Mr. WALKER. I believe it is 2018, Mr. Shaw.
    Mr. SHAW. It just changed recently, and I believe you are 
right. It was 2016. I think it has been changed. So, the same 
thing applies in Social Security, where there are not real--
those Treasury bills are no real economic assets. It is simply 
evidence of a moral obligation that a future Congress is going 
to have to figure out how they are going to pay the benefits 
and how they are going to pay off those Treasury bills. Is that 
not correct?
    Mr. WALKER. That is true, and personally I think that 
Congress has a stewardship obligation. You need to look beyond 
just today. You need to look to future generations and what 
type of burdens are being passed on to them.
    Mr. SHAW. So, I guess regardless of what particular road 
the Congress may decide to go on eventually, we are going to 
have to, if we want to do something, we are going to have to 
start building up in some way real economic assets that the 
Social Security Administration as well as Medicare will have 
some type of a call on, unless we drastically restructure the 
system. Is that not correct?
    Mr. WALKER. Well, we are going to have to do something. 
There are different ways to reform Social Security and 
Medicare. The fact is, the Medicare problem is multiple times 
worse than the Social Security problem.
    Mr. CRANE. Will the gentleman yield?
    Mr. SHAW. I yield.
    Mr. CRANE. Is not one alternative solution also to increase 
the money supply?
    Dr. HOLTZ-EAKIN. No, sir. Over the long term, what will 
serve as resources to pay these obligations of the Federal 
Government and finance the private sector as a whole will be 
the real (inflation-adjusted) economic resources. Those will 
develop independently of movements of the money supply in the 
short term.
    Mr. CRANE. Well, no, my point is that is what we have been 
doing for the last 30 years, is just increasing the money 
supply. We have a steady erosion of the integrity of our 
dollar, and we have had it going on for 30, 35 years.
    Dr. HOLTZ-EAKIN. The evolution of inflation in the United 
States is certainly one that we can discuss at length. I would 
point out that in both the presentations we have adjusted for 
that. We have taken out the inflation components and have 
isolated just the part that has to do with real economic 
growth.
    Mr. CRANE. Oh, I know you have in your projections, but 
what I'm saying is that is one of the alternatives that, sad to 
say, government can fall back on.
    Mr. SHAW. Let me reclaim my time, as it is about to expire. 
Again, as Mr. McCrery asked, on the previous chart that was up 
there, you have not built in any prescription drugs into your 
prediction?
    Mr. WALKER. No, this is the current program. It does not 
include any potential prescription drug benefit.
    Mr. SHAW. I thank you both for your testimony. I wish you 
could have brought us better news, but you have to tell us what 
you think and there is no sense in going after the messenger 
because the real problem lies with us right here. Thank you. 
Yield back.
    Mr. MCCRERY. Mr. Shaw makes an excellent point about the 
savings that we have in the trust fund. To make it crystal 
clear, it is kind of like me telling myself I am going to save 
for my son's college education, and I am going to save 3 
percent of my income. I write a check for 3 percent of my 
income, but instead of putting it in savings, I spend it on a 
car or a house or whatever and I write myself an IOU and put it 
in the drawer. So, that when my son gets to college age, I take 
those IOUs out and spend them on his college education. Well, 
clearly, I have to come up with the money somewhere to pay 
those IOUs.
    Mr. SHAW. Or he doesn't go to college.
    Mr. MCCRERY. Or he doesn't go to college. So, it is an 
excellent point that Mr. Shaw makes. It is not the trust fund 
that we need to worry about so much as it is the cash flow.
    Mr. Levin.
    Mr. LEVIN. Welcome. I was going to ask you about deficits, 
but I have decided not to do so. It is interesting that people 
shift in terms of their attitudes toward deficits. When it 
comes to tax cuts, we have been hearing deficits don't matter. 
Then some of the same people who said that, when it comes to 
their desire to restructure Medicare, deficits are supremely 
important. It seems to me there needs to be some consistency in 
position. Some of us who have thought deficits have mattered 
and acted that way for the last 20 years have tried to be 
consistent.
    It is also interesting, when it comes to estimates, there 
is also kind of the same pragmatic approach, to put it 
charitably. When people want to accomplish a certain purpose--
in this case Medicare and restructuring it--they talk about 
these estimates as if they are divinely decreed. Then, if they 
are defending a so-called growth package, they say what Mitch 
Daniels said just a month ago or 2 months ago, that these 
estimates, 10-year estimates are not just flawed but wildly 
misleading, to quote him exactly.
    So, I think I won't pursue these issues here, but just talk 
about a few other things. By the way, in terms of projection in 
Medicare spending--maybe this isn't fair to the new Director, 
but I think CBO's estimates on Medicare spending the last 6 or 
7 years, as I see the data, those estimates have not been very 
accurate, have they? They have overestimated actual spending in 
their projections. Or maybe you don't have that data.
    Dr. HOLTZ-EAKIN. I don't have the history in front of me. I 
will be happy to provide the history, if you would like that. I 
will point out that in doing its projections, CBO is 
constrained to project current law. In those circumstances, if 
after the projection is made the Congress chooses to alter 
physician payments or other attributes of the Medicare program, 
we will of necessity have our numbers be wrong after the fact. 
It is the nature of the projection process. We can happily go 
back and examine the history and find those situations where we 
might be able to improve it, given that we are constrained to 
project current law.
    Mr. LEVIN. Okay, if you would do that and provide us the 
information. I don't mean to minimize the problem for 1 minute. 
I just think there needs to be a consistency and we should not 
be using these figures to suit our particular purpose and then 
the next week take the opportunity position.
    Let me ask Mr. Walker about your statements on page 2 about 
Medicare's overly generous rates. I just saw some material from 
southeast Michigan hospitals that talked about $40 million 
losses. Would it be possible--I am not sure this is within your 
authority--for you to come to Southeast Michigan and sit down 
with the hospitals and determine what the true picture is? Is 
that something consistent with your----
    Mr. WALKER. Well, Mr. Levin, I don't know that it is 
consistent. I would be happy to talk to you about what may or 
may not be appropriate for us to do. The reimbursement rates 
can vary based upon the type of provider involved, the locality 
involved, and a variety of factors. So, we have to be careful 
when we talk about averages because there can be significant 
variances from averages.
    Mr. LEVIN. Okay, let us do that. By the way, when you talk 
about overly generous rates for certain services and products, 
has that applied in some instances, some substantial instances 
to reimbursements or payments to Health Maintenance 
Organizations (HMOs), to managed care organizations?
    Mr. WALKER. We have reported on that, we have reported on 
skilled nursing, and a variety of things----
    Mr. LEVIN. You have reported on overly generous payments to 
HMOs?
    Mr. WALKER. We have done some work on that and I would be 
happy to provide it to you.
    Mr. LEVIN. Thank you.
    Mr. WALKER. Again, one has to be careful, because there can 
be big variances from the average.
    Mr. LEVIN. That applies to HMOs, to various payment 
structures, right?
    Mr. WALKER. Correct.
    Mr. LEVIN. Thank you.
    Mr. MCCRERY. Mrs. Johnson.
    Mrs. JOHNSON OF CONNECTICUT. Thank you, Mr. Chairman, and 
thanks to both of you for laying out very clearly and quite 
starkly the problem that confronts us with the entitlements. It 
is absolutely clear that we have to add prescription drugs to 
Medicare with that information in mind. It would be very 
helpful, because Members on both sides of the aisle, whether 
they are on this Committee or the Committee on Commerce, in 
this body or the other body, whether on the major Committees or 
off the major Committees, are trying to think this through. I 
think it would be helpful if you took the charts that you did 
for us today, the primary ones having to do with out-year 
growth, and accommodated them for the assumption of $400 
billion spent on increase in Medicare spending for the drug 
bill, 500, 600, 700, 800, 900, and a trillion. There was a 
trillion-dollar proposal last year that had some significant 
Members behind it, and all Members on both sides of the aisle 
need to see what the out-year impact of those different breaks 
would be.
    Then you both testified in one way or another to the 
minimum tools that Medicare has to control spending. So, it 
would be very useful if you could kind of do an analysis for us 
of the major plans, taking primarily the other body's 
Democratic plan--because I think it is fair to say it was the 
best developed. Now, that may not be true, and I would 
certainly allow my Democrat House colleagues to determine what 
plan you should take. For instance, our plan last year had a 
lot of tools in it. Some of them were very controversial. We 
need to see what impact those tools would have on spending 
growth.
    For example, we allowed negotiating below the best price. 
The CBO gave us $18 billion credit for that. We required people 
to actually spend their own money to reach the catastrophic 
threshold--not they're employer's money, not their insurance 
company's money, their own money. That actually, I think, saved 
us, as I recall, $40 billion.
    So, Members on both sides need to see what are some of the 
tools that are employed in the major bills that are out there 
to control spending, and what has been the consequence. For 
example, if you write the premium in law, then you no longer 
have the ability for efficient plans that negotiate a better 
drug benefit for lower cost, to be able to charge less. You 
know, what are the implications of that?
    So, I think we need to get a better grasp, I think all 
Members need to have at their disposal a better grasp of what 
you can do. What happens if you change Medigap law so that 
Medigap is not allowed to cover the deductible and copayaments 
in Medicare? My understanding is that one tool that has worked 
is first dollar responsibility.
    So, I would like you to comment on particularly tools that 
we don't have in Medicare that you think it would be advisable 
for us to consider having because of their impact on cost 
growth. As you comment on that, I would remind you, Dr. Holtz-
Eakin, that we sent you a letter about prescription drugs and 
specific drugs that if people take they stay out of the 
hospital, they don't get in an emergency room, they don't even 
see the doctor as much. Where are we in the science--and you 
might want to comment on this, too, Mr. Walker--the science of 
being able to determine what portion of the prescription drug 
effort will actually reduce hospital and other costs, and how 
could we structure our bills to focus on those drugs in those 
diseases that are most likely to have the effect on the rest of 
the plan of reducing costs. Are any of you doing any analysis 
on the small percentage of seniors that have five chronic 
illnesses and are eating up the majority of the money, and how 
would--so that you can begin helping us think through, how do 
we focus on that? If we focus on the people with chronic 
illnesses, with five chronic illnesses, we should be able to 
reduce costs and at the same time improve quality of care.
    So, I have just laid out some tools here. We will be 
sending you--in fact, I delivered today to you, Dr. Holtz-
Eakin, a binder on the issue of chronic disease management and 
if we are able to feed in the seniors that meet that criteria, 
do we have a potential, and what is that potential in dollar 
amounts, to constrain cost growth and at the same time improve 
the quality of care.
    So, what ideas would you commend to us, what tools would 
you urge us to give Medicare to bend this cost curve?
    Dr. HOLTZ-EAKIN. Well, Congresswoman, if I could take those 
in reverse order. First of all, thank you for the information 
you provided to CBO. We will add it to the wealth of studies 
that we are examining.
    With regard to the ability to identify high-cost patients 
in Medicare, we are looking at the degree to which those high-
cost patients are high-cost patients not just for 1 year, but 
for many years thereafter, and also, the degree to which they 
are identified with particular diagnoses and chronic illnesses. 
These are areas of active study at CBO. We look forward to 
working with you. We have not yet reached firm conclusions on 
the ability to move forward with a specific program to identify 
individuals and estimate cost savings from those kinds of 
approaches, but it is certainly under study.
    On the question before that, the degree to which 
prescription drugs will lower costs elsewhere, we have 
investigated this at some length. To date, while there are 
cases of specific diagnoses--particularly heart disease--where 
one can identify a tradeoff between prescription drugs and 
traditional therapies, on balance, the peer-reviewed literature 
and the research community has not yet reached any kind of an 
indication that we get an overall saving from providing 
prescription drugs. It is an area in which CBO has a lot of 
interest, and we will continue to study it.
    On your first question regarding tools for cost 
containment, I would point you to the broad mantra of 
incentives and opportunity. To the extent that a prescription 
drug provider has incentives to control costs by being at risk 
for the insurance risk in a program and has tools available--
opportunities to control costs by negotiating with 
manufacturers, by picking a single drug out of a class of 
drugs, and a variety of mechanisms of that type--one will get 
better cost containment from providers. The same lesson would 
apply on the beneficiary side as well. I would be happy to work 
with you on the particulars of those lists.
    Mr. WALKER. Mrs. Johnson, we have already done a fair 
amount of work on this and we have other work under way. We 
look forward to working with you and others on it.
    I think you make a good point. The Congress may well decide 
that it wants to update Medicare to include a prescription drug 
benefit because, had you designed Medicare today, you would 
undoubtedly have included a prescription drug benefit. However, 
it is also important to learn the lessons from what has 
happened since 1965 in the design of insurance, of health 
insurance. You need to learn those lessons and try to design 
this benefit in a way that provides incentives to control cost. 
I think you also, frankly, in time are going to have to do the 
same thing for the whole Medicare program. I think you are 
going to have to fundamentally reassess the entire Medicare 
program because as it is presently designed it is 
unsustainable. We don't have the right type of incentives, 
transparency and accountability mechanisms in place, and you 
are ultimately going to have to do it for the whole program.
    Mrs. JOHNSON OF CONNECTICUT. Thank you.
    Mr. MCCRERY. Dr. McDermott.
    Mr. MCDERMOTT. Mr. Chairman, I think we ought to have some 
truth in advertising here. This says this is going to be a 
Committee hearing on expanding coverage on prescription drugs. 
We don't have any plan before us, neither one of the witnesses 
are talking about a plan that anybody is putting forward. So, I 
think what we are talking about is how to get rid of Medicare. 
So, I want to talk a little bit about Medicare.
    Mr. MCCRERY. You may proceed.
    Mr. MCDERMOTT. Dr. Reinhardt in his testimony suggests that 
there is data from the Dartmouth Study that in Texas they spend 
$9,000 per patient, or in Miami, $7,800 per patient, and in 
Oregon they spend $3,600 per patient. Now, there is a recent 
study that came out of the group up at Dartmouth that suggests 
there is no advantage, health-wise or satisfaction-wise, from 
either a double or a triple expenditure in Miami. Where are you 
with a proposal? Now, I say that I look at what happens with 
doctors' fees, where we have set a global budget, and we said 
we were going to control how much money and therefore we figure 
out through the scheme how much we are going to pay. The thing 
we didn't control was utilization. Utilization is out of 
control.
    The same is true in the South, or in many parts of the 
country. I wouldn't just say the South, because it is not only 
in Baton Rouge and in Miami that you get these big 
expenditures, but it is other places. What you find is, it is 
longer hospital stays and it is more specialists seeing 
patients.
    I come from a place where if we were running a health care 
system like the State of Washington or Oregon or Minnesota, 
there would be no Medicare problem here. I wonder what you guys 
have as suggestions of how we fix the present system. What 
answer do you have to the utilization problem? We get as good 
results in Washington State as they get in Miami and Baton 
Rouge, for less than half the amount of money.
    Now, what is the solution? You are both supposed to have 
some ideas here for us, how we are supposed to fix the Medicare 
plan.
    Dr. HOLTZ-EAKIN. You are first.
    Mr. WALKER. Well, first let me say there are probably four 
things primarily driving the overall cost. There's the number 
of persons involved; inflation--both overall inflation, and 
then health care costs in excess of that; there is utilization, 
which you properly point out; and there is intensity, the 
intensity of care. All these factors end up increasing the top 
line on health care costs.
    I would respectfully suggest, for any system to work, 
whether it be health care, whatever system it is, you have to 
have incentives for people to do the right thing, including 
controlling cost, reasonable transparency to make sure 
somebody's looking; and appropriate accountability mechanisms 
if somebody tries to abuse the system. I would respectfully 
suggest our Medicare system does not meet any of those 
criteria. I would be more than happy to provide some 
information for consideration by the Congress.
    Mr. MCDERMOTT. I realize you have made a diagnosis, but 
what is the cure? Tell me the economic--see, I am not an 
economist like you guys are. I don't understand dollars and 
cents. So, I am looking to you to tell me what mechanism you 
put in place for this incentive program.
    Mr. WALKER. Well, for one thing, I think that ultimately 
the Congress is going to need to reconsider fundamentally what 
is the promise. What is the promise in Medicare? Let me give 
you an example.
    If you look at health care, there are several important 
elements. One is guaranteed access at group rates. The second 
is the affordability of that. The third is protection against 
financial ruin due to catastrophic illness. There is room in-
between. You can have guaranteed access to insurance at group 
rates. You could end up providing significant protection 
against financial ruin. You could end up having more cost-
sharing, which is where you need more cost-sharing. Where you 
don't have enough incentives to control cost. I also don't 
think that we have adequate, timely, and useful information to 
analyze what is going on out there. The data that we have for 
health care is often 2 and 3 years old. Health care is a huge 
percentage of our economy. A lot of the data that MEDPAC and 
you have to rely upon to make decisions is old data and it is 
provided by providers, who have a fundamental conflict of 
interest.
    So, I would be happy to be able to provide some information 
for you to consider. It would be a fundamental review and 
assessment of the current system. You need a comprehensive 
review but will probably need to act incrementally.
    Mr. MCDERMOTT. Do you think the 52 percent that 
beneficiaries already pay is not enough incentive to control 
cost? Do you think that they are the ones--is that who? It 
sounds like they are the ones that you think ought to be 
controlling the costs, not the professionals.
    Mr. WALKER. No, I think there is clearly room, both on 
behalf of those who are being paid as well as the 
beneficiaries. So, I don't think it is one side or the other. I 
think there are issues both ways. I would be happy to have a 
conversation with you about it. It is a large subject.
    Mr. MCCRERY. Mr. Ramstad.
    Mr. RAMSTAD. Thank you, Mr. Chairman. Thank you, gentlemen.
    Dr. Holtz-Eakin, I just want to try to get my arms around 
Medicare spending, putting it in a contextual basis, if you 
will. You stated that your projections show at CBO that overall 
Medicare spending is expected to quadruple by the year 2075 to 
more than 9 percent of GDP. I believe that the assumption was 
that we make no major changes to Medicare. Today the size of 
our GDP is roughly at $10 trillion. What does CBO estimate the 
GDP to be in 2075? If it is $10 trillion today, what is it 
going to be in 2075?
    Dr. HOLTZ-EAKIN. That is a number we could get for you. It 
is going to grow over the long term at an average annual rate 
of somewhere between 3 percent and 3\1/4\ percent, and over 
long periods that will add tremendously to the overall size of 
the economy. I can get back to you with the precise number.
    Mr. RAMSTAD. Yeah, because I would like to know if we don't 
make changes to Medicare, then according to your statement one 
can deduce that Medicare spending in 2075 would be 9 percent 
of----
    Dr. HOLTZ-EAKIN. A very large number.
    Mr. RAMSTAD. A very large number.
    Dr. HOLTZ-EAKIN. We can get both large numbers for you, if 
you would like.
    Mr. RAMSTAD. Okay. I think that context is important, 
certainly. Then to follow up your colloquy with Mrs. Johnson, 
did I understand you to say that a prescription drug benefit 
for Medicare seniors should not be enacted without overall 
Medicare reform?
    Dr. HOLTZ-EAKIN. In the end, the Congress will decide the 
best path to go forward. My discussion with Mrs. Johnson was 
about the extent to which prescription drugs--the introduction 
of prescription drugs into a therapy--would provide cost saving 
elsewhere in the medical system. The evidence thus far does not 
indicate automatic cost saving so that you get an offset from 
traditional therapies when you introduce prescription drugs.
    Mr. WALKER. I said that I believed that it would be prudent 
to address both at the same time.
    Mr. RAMSTAD. That is right, it was your colloquy with Mrs. 
Johnson. Excuse me.
    Mr. WALKER. That is correct, that it would be prudent to 
engage in reforms of the program, not just to add on a 
prescription drug benefit. Congress ultimately can do whatever 
it wants, whether it is prudent or not.
    Mr. RAMSTAD. Again, Mr. Walker, asking you the question, is 
it a fair assessment of your statement that a prescription drug 
benefit for Medicare seniors should not be enacted without 
comprehensive Medicare reform?
    Mr. WALKER. My statement says, first, that I think it is 
evident that you are going to do something on prescription 
drugs, and it is arguably needed at this point in time. You 
should be careful about how you design that program, and you 
should also couple it with more comprehensive reforms--not just 
make the long-term situation worse.
    Mr. RAMSTAD. That certainly is responsive to the question. 
I very much appreciate that answer. I think that is what most 
of us believe, at least on this Committee, that to do it 
without the context, not within the context of overall Medicare 
reform is making a serious mistake, for the reasons you cited 
and alluded to.
    I just want to ask in my remaining couple of minutes, Dr. 
Holtz-Eakin, let me also say that I think Congress is fortunate 
to have an economist of your caliber at the helm. You do not 
have an easy job, either one of you gentlemen, and we 
appreciate your good work.
    Most of us, I think, who support a prescription drug 
benefit for seniors do see a cost saving to Medicare. Won't 
there be a cost savings if seniors have greater access to 
prescription drug therapies rather than the more--what is 
documented is more costly and intrusive inpatient and 
outpatient treatments that are currently covered by Medicare?
    Dr. HOLTZ-EAKIN. While I applaud your intuition, in the 
end, when we do the cost estimates, we rely on the evidence 
that is available in the research community as a whole. While 
we have found specific instances in which there are cost 
savings, as a broad statement for the health care system as a 
whole, there is not evidence yet that that is taking place. So, 
I cannot offer that hope to you.
    Mr. RAMSTAD. Well, you are right. My intuition is based 
more on anecdotal experience than empirical data. I would like 
to see the study you allude to.
    Dr. HOLTZ-EAKIN. We will be happy to work with you on that 
and would look forward to any information you might be able to 
provide to CBO.
    Mr. RAMSTAD. It just seems counter-intuitive to me, but 
again, I defer to your empirical data. I would like to see 
those studies, if I could.
    Mr. WALKER. If I can, the evidence is that is not the case. 
The evidence is, is that but for a few exceptions where there 
may be a savings, that he has referred to, that in the 
aggregate there is not a savings.
    Mr. RAMSTAD. Again, to me that seems counter-intuitive, but 
I would like to explore that further. I thank you very much for 
being here today and your responsiveness to my questions.
    Mr. MCCRERY. On the next panel we have some health care 
economists, so maybe they can explore that with us at greater 
length. Generally, I think the response given by the two 
witnesses before us comports with what we have been told by 
health care economists before. Maybe part of the reason for 
that is that most of the medical expense for seniors occurs in 
the last 6 months of their lives. Regardless of the fact that 
we give them preventive care or medications or whatever, 
eventually they are going to get sick and die, and that means 
they are going to have the last 6 months of life which is going 
to be expensive. So, quality of life is one thing, but saving 
money is another. I am not sure the evidence, unfortunately, 
points to significant, if any, savings because of preventive 
care or a health care regimen.
    Mr. Kleczka.
    Mr. KLECZKA. Thank you, Mr. Chairman. I have a few 
concerns. Let me start with Mr. Walker. Could we put that chart 
back up on the trust fund deficit?
    My question, Mr. Walker, is if I were preparing a net worth 
statement for myself, I would naturally list the cash, right? 
If I had a promissory note due me, would that be listed as my 
asset?
    Mr. WALKER. If it was a good promissory note, yes.
    Mr. KLECZKA. No, don't--good, bad, indifferent. It is a 
promise we made. We will make the judgment, not you. If it is a 
promissory note, that would be part of my asset base and end up 
in my net worth, would it not?
    Mr. WALKER. Yes, it would be considered.
    Mr. KLECZKA. Okay, that is why I think this chart is very 
disingenuous, to say the least, because you might contend that 
cash is king, but nevertheless it is not a true picture of the 
entire net worth of the HI Fund. The fact that we have 
promissory notes in the fund is Congress' doing. At the time 
the cash, King Cash, is running out, this Congress or whatever 
Congress is going to have to make the judgment whether or not 
to make it whole. By presenting this chart, and your comments, 
you indicate, well, the money is gone, folks, and let us not 
kid each other, Congress is not going to raise taxes to replace 
it. You know, that is a decision we will make, not the 
comptroller general or the GAO.
    In 2013, if I were to include the trust fund balance, the 
money that is in treasuries, what would be the actual fiscal 
portrayal? In 2013. Right now you have it at almost zero.
    Mr. WALKER. No, at 2013, what happens is you have--the 
annual income that you get from payroll taxes and other 
revenues is not adequate to pay current benefits.
    Mr. KLECZKA. I am fully aware of that. Now, we have been 
amassing a balance over the years because we saw this day 
coming years ago.
    Mr. WALKER. That is correct.
    Mr. KLECZKA. There is in fact a surplus. You chose not to 
reflect it because you are only doing a cash portrayal here.
    Mr. WALKER. No, I have reflected it. If you want to use 
real accounting here, Mr. Kleczka, real accounting, it is a 
$6.2 trillion deficit. That is real accounting.
    Mr. KLECZKA. Okay, now--no, no, no, no. Is there not a 
balance in a trust fund that is not cash, that is promissory 
notes?
    Mr. WALKER. That has value--it has legal significance.
    Mr. KLECZKA. What is that amount?
    Mr. WALKER. The amounts in the HI Trust Fund, let me see.
    Mr. KLECZKA. No, I am looking for a comparison in 2013.
    Mr. WALKER. Two hundred and eight billion dollars----
    Mr. KLECZKA. Two hundred and eight billion dollars?
    Mr. WALKER. In the HI Trust Fund----
    Mr. KLECZKA. For what year?
    Mr. WALKER. At the end of 2001, so at the end of 2002, 
$234.8 billion.
    Mr. KLECZKA. All right, so that blue line would be much 
higher, and by the time you got to the red line, if you did an 
accurate accounting, that red would occur further out and would 
not be as dramatic if you did a true accounting using the 
entire trust fund balance that is in promissory notes.
    Mr. WALKER. Oh, we have that information. I have provided 
that before.
    Mr. KLECZKA. Could you possibly provide it again, maybe in 
an updated form?
    Mr. WALKER. I would be happy to.
    [The information follows:]
       Medicare's Hospital Insurance Trust Fund Balances 2002-25
    Below are the Medicare trustees' 2003 intermediate estimates for 
all years in which the HI Trust Fund is shown to have a positive 
balance.
    Estimates are provided in nominal and real (2003) dollars as of the 
end of calendar years.


----------------------------------------------------------------------------------------------------------------
                                                         HI Trust Fund (EOY)       HI Trust Fund (EOY) (millions
                         CY                                   (millions)                       2003$)
----------------------------------------------------------------------------------------------------------------
            2002                                                        $234,831                       $240,467
----------------------------------------------------------------------------------------------------------------
            2003                                                        $258,537                       $258,537
----------------------------------------------------------------------------------------------------------------
            2004                                                        $282,587                       $275,991
----------------------------------------------------------------------------------------------------------------
            2005                                                        $310,944                       $295,714
----------------------------------------------------------------------------------------------------------------
            2006                                                        $341,790                       $315,828
----------------------------------------------------------------------------------------------------------------
            2007                                                        $375,185                       $336,580
----------------------------------------------------------------------------------------------------------------
            2008                                                        $410,486                       $357,535
----------------------------------------------------------------------------------------------------------------
            2009                                                        $446,563                       $377,612
----------------------------------------------------------------------------------------------------------------
            2010                                                        $482,284                       $395,964
----------------------------------------------------------------------------------------------------------------
            2011                                                        $517,390                       $412,427
----------------------------------------------------------------------------------------------------------------
            2012                                                        $551,710                       $426,954
----------------------------------------------------------------------------------------------------------------
            2013                                                        $583,578                       $438,451
----------------------------------------------------------------------------------------------------------------
            2014                                                        $611,621                       $446,146
----------------------------------------------------------------------------------------------------------------
            2015                                                        $634,426                       $449,310
----------------------------------------------------------------------------------------------------------------
            2016                                                        $649,966                       $446,897
----------------------------------------------------------------------------------------------------------------
            2017                                                        $656,658                       $438,356
----------------------------------------------------------------------------------------------------------------
            2018                                                        $652,578                       $422,928
----------------------------------------------------------------------------------------------------------------
            2019                                                        $635,688                       $399,980
----------------------------------------------------------------------------------------------------------------
            2020                                                        $603,483                       $368,674
----------------------------------------------------------------------------------------------------------------
            2021                                                        $553,018                       $328,006
----------------------------------------------------------------------------------------------------------------
            2022                                                        $480,545                       $276,716
----------------------------------------------------------------------------------------------------------------
            2023                                                        $382,258                       $213,707
----------------------------------------------------------------------------------------------------------------
            2024                                                        $254,600                       $138,189
----------------------------------------------------------------------------------------------------------------
            2025                                                         $93,987                        $49,527
----------------------------------------------------------------------------------------------------------------
Source: GAO analysis and data from the Office of the Actuary, Centers for Medicare & Medicaid Services.


                                 

    Mr. KLECZKA. So, at least we can honestly portray this. No 
one is talking cash-only, even though you might contend cash is 
king. I think you have to look at the total picture. If you are 
right, in year 2013 Congress shies away from making whole the 
trust fund and we don't want to cut spending or whatever to 
make the money whole, we will put up with a riot from those who 
put money into the fund, but nevertheless that is a 
congressional not a GAO decision.
    Let me ask Dr. Holtz-Eakin a question about his chart. This 
is the one that is entitled Medicare Beneficiaries by Income 
Level and Drug Coverage.
    Now, as I look at this chart, at all income levels, the 
blue line is pretty hefty, indicating that seniors have drug 
coverage. Did you do an analysis of what type of coverage we 
are talking about? Is this a moderate policy, is it a Cadillac 
plan, is this a couple of generics, is it a Medicare Choice-
type thing--which naturally they are dropping the drug 
coverage. Is there an analysis of what the blue means? Is that 
decent coverage?
    Dr. HOLTZ-EAKIN. Underneath those numbers are a wide 
variety of plans, in fact--some programs, which are employer--
--
    Mr. KLECZKA. Medicare is in there also?
    Dr. HOLTZ-EAKIN. This is coverage of any type. So, it is 
also employer-provided plans and Medigap policies. To the 
extent that they have coverage from any source, it is reflected 
in this----
    Mr. KLECZKA. So, it goes from low to high. So, it is not 
really an indicator for the Committee or for the Congress that 
there is adequate coverage out there, or sufficient, or a 
decent benefit being provided to seniors? It is just who has 
anything?
    Dr. HOLTZ-EAKIN. To the extent that we were trying to 
capture that, it is in the other graphs that show the degree to 
which beneficiaries would face out-of-pocket expenses versus 
covered expenses.
    Mr. KLECZKA. Have either or both of you gentlemen looked at 
the President's drug plan that he submitted to the Congress?
    Mr. WALKER. I have not analyzed the President's plan.
    Dr. HOLTZ-EAKIN. The President provided insufficient 
evidence for CBO to do any real analysis of it, as we discussed 
in our analysis of the President's budget that we put out in 
March.
    Mr. STARK. Would the gentleman yield?
    Mr. MCCRERY. The gentleman's time has expired.
    Ms. Dunn.
    Mr. STARK. I guess not.
    Ms. DUNN. Thank you very much, Mr. Chairman. Thank you for 
being here gentlemen. Mr. Walker, I want to go to a point that 
Mr. McDermott touched on briefly. In your testimony you stated 
that Medicare pays overly generous rates. That is not, we feel 
in my State of Washington, necessarily close to the truth. You 
also mentioned that Medicare's payments are based on averages. 
I am very concerned about the variation in payments from one 
region to another. I am wondering if you come to us with any 
recommendations to create more equity in these payments. For 
example, do you have recommendations on the formula that is 
used to determine these payments?
    Mr. WALKER. Not today, Ms. Dunn. Let me say that what is in 
my testimony talks about the fact that GAO has done work that 
in some cases there are over-generous payments, not in all 
cases. We have also done work to show that there can be 
significant differences in what reimbursement rates are in 
different regions of the country, and also the reasonableness 
of what those reimbursements are between different types of 
providers. So, it is not a one-size-fits-all. I would be more 
than happy to follow up with you after the hearing, if you 
want.
    Ms. DUNN. Yeah, I would appreciate that. It is a continuing 
problem in our State, where we believe we produce the best 
medical care available in the country, and yet we are having a 
hard time holding onto our doctors and keeping our hospital 
doors open because the reimbursements aren't there at the same 
rate that they are in many other States whose quality of care 
is not any better than ours.
    Mr. Walker, let me ask you, too, about a GAO report that 
was released in January. It was on the role of the 
pharmaceutical benefits managers (PBM) in the Federal Employee 
Health Benefits program. I am wondering if you can summarize 
your findings in that report. Did beneficiaries, for example, 
have sufficient access, do you think, to retail pharmacies?
    Mr. WALKER. I think the bottom line in that report is that 
PBMs are a tool that had been used, including by the Federal 
Employees Health Benefit Plan. It is a mechanism that the 
Congress may well want to consider in conjunction with 
providing a prescription drug benefit under Medicare. There 
are, however, some differences between how Medicare 
historically has been arranged--any willing provider, and so 
forth. There is an opportunity for cost savings here with 
regard to PBMs, but there are some adjustments that are going 
to need to be made if you're thinking about doing it under 
Medicare.
    Ms. DUNN. Your comment on access to retail pharmacies?
    Mr. WALKER. Most have a broad network. It can vary, but 
yes, there are access to retail pharmacies in some 
circumstances, yes.
    Ms. DUNN. Thank you. Thank you, Mr. Chairman.
    Mr. MCCRERY. Mr. Portman.
    Mr. PORTMAN. Thank you, Mr. Chairman. Let me start off, if 
I could, by following up on Ms. Dunn's question. Your GAO 
report with regard to pharmacy benefit managers, it seems to 
me, gave us some good information with regard to the so-called 
brick-and-mortar or retail pharmacies. Many of them were quite 
concerned with the bill that was enacted--not enacted, but 
passed by this Committee and by the House of Representatives 
last year. Despite the fact that we did not allow direct-mail 
pharmacies to have a dominant position, still they were 
concerned that they might not be accessed by the Medicare 
prescription drug plan we put forward. So, I think to the 
extent you can provide us this new information in relation to 
this new legislation we are hoping to put together this year, 
it would be very helpful.
    What I took from it was that in the experience of the 
Federal Employee Health Plan, that in fact there was access to 
retail pharmacies. Perhaps that is a good example for us to use 
and to try to allay some of those concerns, because all of us 
have them, particularly those of us who represent small towns 
where you have pharmacies that really provide more than just 
the prescription drug, but also more health maintenance and 
preventive health for beneficiaries.
    I would like to go back, though, if I could, to some of 
your earlier testimony. I apologize that you have to sit here 
and be told by some of our Committee Members that you are 
coming here to tell us how to get rid of Medicare. I feel just 
the opportunity about it. I think that is offensive to you, two 
professionals who, in the case of Mr. Walker, I know has spent 
a lot of time on this issue, and to our newest CBO Director.
    I appreciate the fact that you are giving us what I view as 
straight talk. This is a very politically charged issue, as you 
have seen here this morning. Again, Mr. Walker knows that from 
working on it in the past. We need good data. I thought you 
were responsible in terms of how you presented the solvency 
issue because it is true that the lines do cross at 2013. It is 
true that then Congress has choices to make. You laid out those 
choices very specifically, including borrowing, including tax 
increases, including reducing benefits. These are tough choices 
that, in my view, Congress will have a very tough time making 
in 10 short years.
    So, I thank you for bringing focus on that. We constantly 
hear that the year is 2027 or, now, 2026. So, I think, if 
anything, we need to bring more focus on the fact that we have 
a fiscal crisis that is more imminent. So, I appreciate that. I 
also appreciate the fact, again, you laid out what the options 
are at that point. So, I thank you for that.
    I guess my question for you, Mr. Walker, would be, when you 
talk about ``true accounting,'' you said in fact there would be 
a deficit--I believe you indicated that in response to Mr. 
Kleczka's question--at 2013. What did you mean by that?
    Mr. WALKER. Well, what I meant by that was, if you were 
actually preparing a net worth statement and you were using 
accrual concepts, where you were trying to estimate what the 
discounted present value of what your future promises are and 
you look at what is the discounted present value of the revenue 
stream that you have to meet those promises, what is the gap, 
there is a $6.2 trillion gap for HI. I am just trying to 
provide the facts. Congress is elected, Congress has to make 
the judgments on what to do with the facts. Sometimes people 
don't like the facts, but they are nonetheless the facts.
    Second, as you properly point out, and I appreciate it, I 
was a trustee in Medicare for 5 years. I care very deeply about 
Social Security and Medicare. I was a trustee of Social 
Security as well. We have to start dealing with the facts.
    Mr. PORTMAN. Well, I appreciate that and I think, again, I 
view it just the opportunity. We are not talking about how to 
get rid of Medicare, we are talking about how to save Medicare. 
When you look at the demographic challenge we face with people 
living longer and with more and more baby boomers retiring--and 
I appreciate also the fact that your charts today indicate 
that, how much of it is due to the Medicare health care cost 
increases and that inflation is still, in my view, way too high 
to be sustained, but also just the aging population. My 98 year 
old grandmother, who is right now back in Cincinnati--if C-SPAN 
was on, she would probably be watching this, still very sharp--
God bless her, but there are more and more people in that 
situation. Eighty-year-olds are our fastest growing group. So, 
it is important that you lay that out, too. It is not just the 
fact that health care costs are increasing at unsustainable 
levels; it is this aging population.
    Quickly to CBO: Your challenge is to help us determine 
whether some of these competition models really save money. I 
know that you have looked at some of these proposals. You 
indicated you hadn't looked at the President's proposal. My 
understanding is you have done some preliminary analysis of 
some of the proposals that they have for competition, and you 
have indicated they do not have significant savings. Is that 
not accurate?
    Dr. HOLTZ-EAKIN. To date, we have had staff-level 
discussions on a variety of prototypes and thoughts. It is an 
overstatement to say that CBO has scored any specific proposal, 
the President's or otherwise.
    Mr. PORTMAN. Well, we appreciate your focusing on that over 
the next several months, because it is going to be critical to 
us to figure out how to keep high quality of care and deal with 
this huge challenge. I know you will look at it creatively, 
because some of the existing models, I think, are inadequate. 
Maybe the Federal Employee Health Benefits Plan that GAO looked 
at is one model. Any models out there with regard to 
competition--choice, which is something that our seniors want--
we certainly look forward to, because the existing model is not 
one that can be sustained. Therefore it is a failed model.
    Thank you, Mr. Chairman.
    Mr. MCCRERY. Mr. Pomeroy.
    Mr. POMEROY. Thank you, Mr. Chairman. I would like to begin 
by yielding such time as he may consume, but I hope it is not 
much, to Mr. Stark.
    Mr. STARK. I just want to go back, Dr. Holtz-Eakin. You 
said that there wasn't adequate information on the President's 
plan for you to estimate it. Did I hear that in response to a 
question back one or two?
    Dr. HOLTZ-EAKIN. In March, CBO conducted its traditional 
analysis of the President's budgetary proposals. The 
information we had at that time was that there was to be a 
Medicare prescription drug proposal that would cost $400 
billion over 10 years. That was the extent of the information.
    Mr. STARK. I did want to, and I heard Mr. Portman allude to 
this, too, that there was, according to the Wall Street 
Journal's weekly gossip sheet here, a very high-ranking 
government official who recently told some Members of the other 
body that the Medicare overhaul plan could add hundreds of 
billions of dollars in costs and that the Administration's 
cost-savings claims for its plan were disputed by the early 
data of a demonstration project. Small savings from encouraging 
seniors to opt for private plans would be offset by high 
administrative costs. I presume that--of course, that was just 
a shot in the dark by somebody who obviously didn't have 
adequate information on the President's plan.
    Mr. MCCRERY. In court we would call that hearsay.
    Mr. Pomeroy.
    Mr. POMEROY. Thank you. First of all, I want to salute each 
of you for your work. In particular, David Walker and I have 
had a chance to work together for years. I think we really have 
a winner with the comptroller general, a top-flight account, 
manager, and a health policy guru besides. So, you can 
certainly make a very important contribution going forward. I 
look forward to working with you in that regard.
    I think your testimony on page 14 is very interesting. 
Well, your testimony is interesting throughout, Mr. Walker, but 
I really like on page 14, you talk about basically, making 
government fit the challenges of the future will require not 
only dealing with the drivers, such as entitlements for the 
elderly, but looking at the range of other government 
activities. Fundamental review of what the Federal Government 
does and how well it does it will be needed. This involves--and 
this is the most important part in my opinion, relative to what 
faces this Congress at this day: This involves looking at the 
base of all major spending and tax policies to assess their 
appropriateness, priority, affordability, and sustainability in 
the years ahead.
    So, we had some discussion today about addressing 
prescription drugs in the context of an overall Medicare 
package, but it seems to me we ought to talk about Medicare 
much more in the context of the overall budget, especially the 
tax cuts that are the centerpiece of the Administration's, the 
House-passed plan.
    Clearly a diminished revenue picture in light of the tax 
cuts proposed--first the growth package and follow along making 
the tax cuts permanent--will have what effect, Mr. Walker, on 
the ability of the Federal Government to meet these Medicare 
payments on a cash-flow basis as they come in in the next 
decade?
    Mr. WALKER. It will reduce the revenues available. I try to 
be an equal opportunity fact-provider. That is generally to be 
consistent and to be transparent. We have done a simulation 
that shows what the effect would be if Congress decided not to 
extend the tax cuts. It would have an effect, but it is not 
enough of an effect to solve the problem. We are still going to 
need to do what you read in my testimony. The difference may be 
less, but there is still a significant gap in----
    Mr. POMEROY. Absolutely. I am certainly not suggesting it 
is simply a matter of just not doing tax cuts, everything is 
rosy. I think we also have to come to grips with the fact that 
we are making a difficult situation a great deal worse, are 
quite possibly putting us in a framework where we really can't 
prudently commit the long-term commitment of a Medicare reform, 
including prescription drugs, if we would so significantly 
reduce the Federal revenue base.
    Mr. WALKER. I think you need to consider it in the broader 
context. I think there are three levels--the overall fiscal 
challenge, health care, and Medicare. I believe you need to 
look at all of those.
    Mr. POMEROY. Mr. Walker, because we operate in a 10-year 
budget window, but that really misses just around the corner 
what happens when the baby boomers retire and the costs hit, is 
there some analysis that you could do, or CBO could do, that 
would somehow help us as we look at revenue issues now what 
that means in terms of impact next decade relative to meeting 
these existing commitments, the Social Security and Medicare?
    Mr. WALKER. Well, I think one of the graphics that I showed 
was the long-range budget simulation gives you a feel for that. 
One of the things I believe Congress needs to consider before 
it enacts legislation is that you need to consider the 
discounted present value cost of both spending and tax sides 
before you make the decisions. You need to consider what the 
bottom-line impact is. I believe that is very important, and 
should be consistent on both sides.
    I should also say one last thing. I think this Committee, 
Ways and Means, also needs to look very hard at existing tax 
incentives for health care. I would respectfully suggest that 
they are making many consumers less aware of the cost of health 
care and maybe fueling health care cost increases.
    Mr. MCCRERY. Thank the gentleman for that astute comment.
    Mr. Hulshof.
    Mr. HULSHOF. Thanks, Mr. Chairman. Those that will examine 
this record will examine the entire record, I feel compelled to 
respond to some of those who commented earlier, specifically to 
the Ranking Member and the gentleman from Washington State. It 
seems interesting, Mr. Chairman, that when the full Committee 
meets to consider a Chairman's mark, we hear protestations 
about the fact we have not held hearings. Today we are holding 
hearings, and the objection from the other side, the lament, is 
that we don't have a bill to consider. Which reminds me of an 
old law school axiom: When the facts are against you, you argue 
the law; when the law is against you, you argue the facts; and 
when the facts and the law are against you, you pound the 
podium.
    I would also say to the gentleman from North by-gosh 
Dakota, my friend--and even to Mr. Levin of Michigan earlier--
who were talking about 10-year projection numbers. Mr. Levin 
specifically decried ``the use of figures for particular 
political interests.'' I think I jotted his comment down 
adequately. As recently as 1997, when this full Committee 
considered the Balanced Budget Act, there was never a hint or 
argument about a 10-year projection. There were 5-year numbers, 
because the House operates under 5-year numbers. It is only 
since then that not only do we talk about 10-year implications, 
but now 15 and 20 and 30 year implications about tax cuts and 
the like. So, I think I just wanted to insert that editorial 
comment of my own and then get to a question.
    Dr. Holtz-Eakin, I am also privileged to serve on the 
Committee on the Budget along with this Committee. As we 
debated the Medicare proposal, prescription drug and 
modernization--and I do include those worlds equally, I would 
say that I think the CBO estimate alone may not fully inform us 
of the consequences of various prescription drug proposals. Let 
me ask your comments on that.
    We could have a $400 billion proposal that might lead to 
lower costs for purchasing prescription drugs, it could lead to 
more marketplace competition, it could lead to more innovative 
drugs being introduced into the marketplace. Or we could have a 
$400 billion proposal that could lead to no additional 
innovation, no price stabilization. So, really, what we choose 
to do--we can have this $400 billion new proposal, and yet 
depending on which direction we go, and each of you talked 
about innovations and incentives and consequences of those 
incentives, how critical is it from an economist's perspective 
that any Medicare modernization bill or prescription drug bill 
encourage competition among private firms, increase access by 
new firms and encourage innovation for new drugs and 
technologies?
    Dr. HOLTZ-EAKIN. Speaking as an economist, it may be the 
case that, consistent with the charts we showed you, this 
Nation chooses to spend an increasing fraction of its wealth on 
medical care broadly defined. However, for those dollars to be 
used wisely, one must give participants the incentives and 
opportunity to channel those dollars to those particular drugs 
or therapies that are the ones that they value the most highly, 
and that is the traditional economic route to getting high 
value per dollar.
    Mr. HULSHOF. To go even--and to look at our current 
Medicare program, the current fee-for-service program is an any 
willing provider program. If we perpetuate that structure in a 
prescription drug program and we put aside the use of 
formularies or select contracting with pharmacies, what impact 
would that have on our ability to control costs? Maybe another 
way to ask you the question is, what incentives are there to 
control costs if the government holds 100 percent of the risk?
    Dr. HOLTZ-EAKIN. I think a concrete way to answer the 
question is to look back at previous CBO analyses of 
prescription drug proposals in previous Congresses and look at 
those situations in which there were perceived to be cost-
containment incentives and opportunities on the part of 
providers--whether they were at risk for the insurance losses, 
whether they had tools available to choose low-priced drugs, 
whether there were price signals sent to beneficiaries to 
choose among providers on the basis of costs. All of those 
things figured into CBO's cost estimates.
    Mr. HULSHOF. I appreciate both of you gentlemen, especially 
with the charts, which I think are quite telling. I have back 
in Missouri a fairly substantial town meeting coming up, and 
would ask the opportunity to use these charts that you have 
shown to us today to help explain some of the challenges that 
we have because I think they are quite telling.
    Mr. MCCRERY. Mr. English.
    Mr. ENGLISH. Mr. Chairman, will yield my time to Mr. 
Portman.
    Mr. PORTMAN. Well, thank you, Mr. English. I didn't know I 
would have this opportunity, but let me go back to some of the 
earlier questions and some of the legitimate concerns that were 
raised on proposals that might be before this Committee and 
just make what is maybe an obvious point.
    Medicare and Social Security, as well as some other major 
controversial and, as I said earlier, politically controversial 
issues should be handled on a bipartisan basis, really have to 
be to be successful. I think it was President Jefferson who 
said a big issue should be more of a point of consensus rather 
than a bare minority or a bare majority.
    One of my concerns is that, as we criticize the various 
proposals, we are not hearing alternatives from the other side 
of the aisle as to what they would do with regard to these I 
think now well-defined solvency issues.
    So, I would just urge my colleagues on the other side give 
us your best ideas. We could always come up with a Medicare 
prescription drug coverage plan that costs $1 trillion a year 
or $1 trillion over the 10-year period, and Mrs. Johnson talked 
about that, that would be politically popular in certain 
circles. It would not be the responsible thing to do.
    We, instead, are trying to both provide this needed 
coverage which, in the modern day, must be there, but also 
modernize the program itself so that it can be sustained over 
time. So, I would just make the obvious point that, while it is 
easy to criticize and to poke holes in the various proposals 
that are going to come up, the responsible thing would be to 
offer alternative proposals.
    In the area of Social Security, we have the 75 year 
solvency standard criteria. I would suggest here the criteria 
might be some of the challenges you have faced us with today, 
including the crossing of the line, as I said earlier, between 
the revenue coming in, and the benefits being paid out in 2013 
or even pushing it back to 2026, coming up with some way to 
fund that interim period, but we need to have some standards, 
and I wonder if the two of you could perhaps comment on that, 
putting you on the spot here of, maybe Dr. Holtz-Eakin, you 
could go first. What should the standards be for Medicare 
modernization and prescription drug proposals that we could 
compare, instead of apples to oranges, apples to apples? What 
would you say would be the appropriate criteria?
    Dr. HOLTZ-EAKIN. In that area, I guess I would offer two 
thoughts. The first is that we presented our analysis of the 
long-run trajectory for Medicare looking at the current program 
relative to the size of the economy, and I think that is a 
useful baseline to use because it makes the point that in the 
end, the economy is the ultimate source of all of the resources 
to be devoted to health care and other needs. The second point 
is that the financing mechanisms that the Congress might choose 
to meet those needs are at their disposal. It could be debt 
financing; it could be tax financing or we could choose to 
lower the trajectory for Medicare outlays.
    So, I think that the right standard is to compare programs 
relative to the economy--especially over the long term--when 
making decisions in the present that have long-term 
consequences.
    With respect to comparing proposals on an apples-to-apples 
basis, the traditional way to do so is to attempt to make sure 
that proposals have the same value per dollar, and I can offer 
you only small comfort in that regard because whether a 
proposal is ``worth it'' in the eyes of the Congress will 
ultimately be your decision. We can provide you with the 
dollars and allow you to compare the dollars on an equal basis. 
Whether their proposals are worth it or not is a larger 
question.
    Mr. PORTMAN. Mr. Walker.
    Mr. WALKER. Mr. Portman, the GAO did some work in 
conjunction with Social Security, where we came up with a list 
of questions that we recommended that the Congress consider in 
deliberating any Social Security reform proposal. We are in the 
process of doing the same thing for health care, and I expect 
that that will be done within the next month. I would 
respectfully suggest that this Committee and the Congress as a 
whole may want to consider these questions in analyzing various 
proposals. We can be helpful in that regard, but in the final 
analysis, you are the elected officials. You have to make the 
judgments as to what is appropriate to do.
    I will agree with Doug to say that I think looking at 
things as a percentage of the economy, a percentage of the 
budget in different ways, moving beyond trust funds, which are 
really not trust funds in Webster's Dictionary. They are 
accounting devices. That is what they are, nothing more, 
nothing less.
    Mr. PORTMAN. I think you have made that point clearly today 
early in your testimony, and I would just respectfully say that 
if you look at, as a percentage of our economy or as a 
percentage of our budget, what mandatory spending is, in 
general, of course, we have seen dramatic increases, and the 
projections are for even greater increases, I am not sure that 
that criteria is one that we would adhere to as Members.
    So, anything you can give us, in terms of those questions 
or even in terms of just establishing some criteria to be able 
to compare the various proposals on a fiscal basis would be 
very helpful.
    Mr. WALKER. Ours cover much more than cost. They cover 
access administration, quality and other issues.
    Mr. PORTMAN. Right, quality issues.
    Mr. WALKER. It is a much more balanced approach. It is not 
just focused on cost because in the end you need to consider 
more than just cost.
    Mr. PORTMAN. Right. Thank you, Mr. Chairman.
    Mr. MCCRERY. Mr. Becerra.
    Mr. BECERRA. Thank you, Mr. Chairman, and thank you to the 
two of you for your testimony and your time.
    I would like to, if I can actually for 1 second, refer back 
to the GAO chart. I want to make sure I am clear on something. 
In terms of the out-years, in 2050, the largest component that 
you identified there is net interest, and I am assuming that 
means the interest we pay on the national debt.
    Mr. WALKER. That is correct.
    Mr. BECERRA. It seems that it is not much smaller than the 
combined costs of Medicare, Medicaid and Social Security come 
2050. I know that the Congressman from North Dakota was asking 
some questions with regards to this, and I would like to follow 
up on what Mr. Pomeroy was asking.
    If we believe that the size of the debt, which will require 
interest payments larger than any other of these other programs 
and almost as large as three of our greatest programs combined, 
would it not seem that we would want to be making decisions 
today that help us decrease the size of the national debt, and 
therefore decrease not just for this year, but in the out-years 
the amount of interest payments we will be making on that debt?
    Mr. WALKER. I think a different way of saying it is 
deficits do matter. It is important. Obviously, the amount of 
the deficit, the nature of the deficit, the timing of the 
deficit--is it a time of war or recession--should be 
considered, but ultimately you need to get back into balance 
over the long term.
    Mr. BECERRA. If I am correct, the President's budget 
proposal would have us with a deficit for each of the 10 years, 
in the succeeding 10 years of his plan, and thereby increasing 
the size of the national debt. If we were to eliminate his 
proposals to, one, permanently extend the 2001 tax cut, which 
is factored into this chart, but also eliminate the other 
proposed tax cut that he has of some $700 billion over 10 
years, principally with regards to dividend repeal, tax repeal, 
would we see that very dark blue and large box under the year 
2050 that represents net interest also come down?
    Mr. WALKER. That is correct. We have done that. It would 
come down, and it would come down significantly. It would still 
be significantly higher than it is today, and you would still 
have a significant long-range problem to deal with.
    Mr. BECERRA. So, even if we were to cut all of the 
President's tax cuts, we still have a lot of work to do because 
there is a lot more that goes into making the national debt and 
the annual deficits that we are facing than just the tax cut. I 
think most folks understand that, but we have got to, at some 
point as you said, start to bring this budget back into 
balance.
    Certainly, if we are going to see a net interest payment 
that large, representing that high a percentage of our GDP, it 
would seem that we would want to start now to move toward that 
road of fiscal responsibility.
    Let me ask another question. Dr. Holtz-Eakin, I think you 
mentioned this in earlier testimony that about 70 percent of 
Medicare's growth is due to excess health care cost growth 
which, as I think you have mentioned in the past, is not unique 
to Medicare. The private sector has faced this as well.
    If the private sector isn't doing much better or any 
better, and some people would say it is doing worse, but if it 
is not doing any better than Medicare at controlling the growth 
and its costs, and in fact I think most people would agree that 
Medicare has done a better job than the private insurers in 
curtailing costs, how do we expect a program that would turn 
over, as the President proposes in his plan, Medicare or 
prescription drug benefits to private plans, in essence, 
privatizing senior's health care, at least for prescription 
drugs, how would that help us reduce costs under Medicare?
    Dr. HOLTZ-EAKIN. There are really two answers to your 
questions. The first is that if one looks historically, if one 
goes back and looks at growth of costs for private-sector 
payers and growth of costs under Medicare, while on a year-to-
year basis Medicare may be above or below the private sector, 
but on balance, they tend to end up in roughly the same place.
    Mr. BECERRA. Pretty close.
    Dr. HOLTZ-EAKIN. So, I wouldn't characterize one as being 
faster or slower than the other in any sustained way.
    Then with respect to any proposals on prescription drugs 
and their cost-containment features, I would refer back to the 
things that I have mentioned already in my testimony.
    The degree to which there will be cost containment depends 
on--in many, many detailed ways--on the particulars of the 
proposal and the degree to which there are features such as 
providers who are at risk and have incentives to control their 
costs, beneficiaries who are responsive to price signals and 
face some incentive to minimize costs, and a wide variety of 
other features of the proposal. As a blanket statement, it is 
impossible to characterize how that comes out.
    Mr. BECERRA. Mr. Chairman, I know my time has expired, if I 
could ask one last quick question. Do either of you believe 
that we could try to maintain the cost in a private-sector 
plan, when it comes to administrative costs at least, or those 
costs that are ancillary to the actual provision of health 
care. So, in the case of Medicare, we are talking about 
administrative costs, and in the case of a private plan, the 
administrative costs would probably be complemented with 
marketing costs and profit that would have to be added for the 
private plan.
    Is there any way that we could try to corral those costs 
for any private plan so that they are about what Medicare 
currently pays in administrative costs, which I understand is 
about 3 percent?
    Dr. HOLTZ-EAKIN. The evidence is, thus far, for existing 
private plans versus Medicare, is that administrative costs are 
higher for HMOs and Preferred Provider Organizations (PPOs) 
that we see. Going forward, how that would play out remains to 
be seen.
    Mr. MCCRERY. Mr. Cardin.
    Mr. CARDIN. Thank you, Mr. Chairman, and let me thank both 
of our witnesses. I am not sure we are asking the right 
question. So, let me see if I can at least get your view on 
this. We are looking at this to try to save the Federal 
Government money in the Medicare system, which I understand are 
the growth of the cost to the Federal taxpayer, but it seems to 
me that we are talking about health care costs increasing. To 
the extent that we put in these so-called reforms or deal with 
the changes as to what the Federal Government will pay, we may 
very well be adding to the burden of the individual and not 
really dealing with reducing health care costs or the growth of 
health care costs in the country.
    I am looking at MEDPAC's study, which indicates today that 
for all beneficiaries, including institutionalized, and those 
in Medicare+Choice (M+C), Medicare covers 52 percent of the 
total cost. So, a large part is already being paid for by the 
beneficiaries directly and not by the Federal taxpayer.
    Then according to MEDPAC analysis of Medicare Current 
Beneficiary Survey (MCBS), growth in out-of-pocket costs for 
fee-for-service beneficiaries living in the community has 
outpaced growth and their income. The largest source of out-of-
pocket growth has been for non-covered services.
    I could also go into those that are in some form of a 
managed care plan. The coverage for non-covered service has 
been shrinking. So, it seems to me that when you put that all 
together, we run a real danger of putting a lot of pressure 
here to reduce the Federal taxpayer share, but in fact will be 
placing more burdens on the individual. I would just appreciate 
your comments. Are we looking at this the wrong way?
    Mr. WALKER. Well, first, I think you have to keep in mind 
that that 52 percent number, as I understand it, just talks 
about Medicare, that you have Medigap paying costs----
    Mr. CARDIN. That, in many cases, is 100 percent of the 
costs----
    Mr. WALKER. No, it is not 100 percent, but you have got to 
consider that Medigap is paying costs, and employers are paying 
costs with regard to retiree health care.
    Mr. CARDIN. On every one of those cases, the individual 
beneficiary is paying for that. It may be paying for it in 
salary compensation, may be paying for it in full cost of the 
Medigap premiums. They might have some help through their prior 
employment arrangement----
    Mr. WALKER. Right.
    Mr. CARDIN. Low-income people of course get some help. As 
far as the Medicare system, it is not paying it.
    Mr. WALKER. I understand, but the other thing you have to 
keep in mind with those numbers is that they also include 
nursing home costs, and one could debate whether that is solely 
a health care cost. I don't believe that is solely a health 
care cost. Some of the services that are provided are not 
health-care related services when you are in a nursing home; 
housing or basic food, subsistence----
    Mr. CARDIN. I think that is a good point on the 52 percent, 
but it still points out that if we are just shifting who is 
paying the cost here, the seniors, as a class, are already 
burdened in their out-of-pocket costs as it affects their 
standard of living that they have to pay for health care.
    Mr. WALKER. Mr. Cardin, you might not have been here when I 
mentioned that GAO is preparing a briefing report that I think 
would be helpful to this Committee and the Congress on what has 
happened in health care in the last number of years. I think 
you will be surprised to see that in the aggregate, the 
individual's portion of health care costs has gone down 
dramatically in the last 40 years, the percentage being paid by 
individuals, in the aggregate, of overall health care costs, 
but that varies by----
    Mr. CARDIN. Does that include seniors? Are you saying 
seniors' costs have gone down?
    Mr. WALKER. It varies by age group, but in the aggregate, 
if you look at who was paying health care costs back years 
ago----
    Mr. CARDIN. Well, I would be curious to see how that breaks 
down by seniors.
    Mr. WALKER. Sure.
    Mr. CARDIN. That is what we are talking about today.
    Mr. WALKER. I understand that. No, I understand that.
    Mrs. JOHNSON OF CONNECTICUT. Will the gentleman yield a 
minute?
    Mr. CARDIN. I would be glad to.
    Mrs. JOHNSON OF CONNECTICUT. I think the point of your 
question was does people taking first-dollar coverage have an 
impact on utilization or is it just shifting who pays?
    Mr. CARDIN. Well, I am not sure about that because the 
utilization issue is a separate issue, and there has been no 
demonstration that we will get, there are over-utilizations 
adding to the cost here.
    Let me ask one more question, if I might, because my time 
is running short. The Chairman mentioned in the beginning $400 
billion is in the budget for a Medicare prescription drug plan. 
Can you tell us just very quickly is that anywhere near enough 
money, in the ballpark, to cover a prescription drug plan which 
is typical for those under 65 that they have in commercial 
insurance, such as what Members of Congress would have in the 
Federal Employees Health Benefit plans? Would $400 billion come 
close to covering those types of costs? Just so we have some 
yardstick here as to the moneys that are being put on the 
table.
    Dr. HOLTZ-EAKIN. Mr. Congressman, I guess if I could ask a 
little clarification. When you say ``those costs,'' which costs 
do you refer to? Our baseline has about----
    Mr. CARDIN. If we were going to provide the benefits of a 
typical plan provided those under 65, such as the Federal 
Employees Health Benefit Plan prescription drug coverage, how 
much money would it cost over 10 years?
    Dr. HOLTZ-EAKIN. The reason I asked is that if you go back 
to the charts we pointed out, out of a baseline of, say, $1.8 
trillion, roughly three-eighths, or about $600 billion is 
currently out-of-pocket. If those costs are what you are trying 
to cover, then $400 billion is two-thirds of that.
    If you are trying to construct a prescription benefit plan 
that would replace current sources of insurance coverage for 
prescription drugs, then the number would be much larger. So, 
it really depends upon the objective that you have in mind.
    Mr. CARDIN. In any case, it would be much larger than $400 
billion. If we had no deductibles and 25 percent co-pays, I am 
just looking at the Blue Cross Standard Option Plan, which has 
a 25 percent co-insurance, no gaps in coverage, stop loss for 
all medical benefits, that would cost well in excess of $400 
billion, I take it.
    Dr. HOLTZ-EAKIN. Clearly.
    Mr. CARDIN. Thank you, Mr. Chairman.
    Mr. MCCRERY. Mr. Stark, you have a quick follow-up?
    Mr. STARK. I just wanted to comment on Dr. Holtz-Eakin's 
statement previously that the difference in increasing costs 
between Medicare and private plans. I am not sure that that is 
quite correct.
    Dr. Moon's study recently indicated that over the previous 
30 years, health care cost increases for private insurance was 
41 percent higher than Medicare. Now, for the first 15 years, 
approximately, they were almost identical, but that was prior 
to our putting any real cost controls into Medicare, and since 
we have put cost controls into Medicare, the rate of increase 
of the private insurers has been far higher in the last part of 
that 30-year period in every year and to a significant degree, 
and I would not want the record to suggest that private plans 
come anywhere close to the Medicare system insofar as 
controlling increase in costs.
    Dr. HOLTZ-EAKIN. I am not familiar with the details of that 
study. We would appreciate getting a copy.
    Mr. STARK. Yes, you certainly should be.
    Dr. HOLTZ-EAKIN. I would caution that, in making these 
comparisons, making sure that you compare apples with apples is 
usually the hard part.
    Mr. STARK. She adjusted this to age and, indeed, this was 
adjusted to compare exactly because there are two different 
populations, and this was thus adjusted.
    Mr. MCCRERY. Well, I appreciate the gentleman bringing that 
to our attention. I wonder if she included, though, things like 
compliance costs that the Medicare program imposes on the 
private sector that they have to comply with, and that is 
probably not accounted for in her numbers or certainly not in 
the 3-percent figure that we hear all the time, as far as the 
administrative costs of the Medicare system. I wonder if our 
witnesses would like to comment on whether the Medicare 
compliance costs are figured in when we talk about 
administrative costs.
    Dr. HOLTZ-EAKIN. With regard to the comparisons that are on 
the table, the compliance costs I can get back to--I do not 
know the details there. The CBO looked at the study, and we 
have a different interpretation of the historical data. In 
particular, the apples-to-apples comparison requires comparable 
benefits. I would be happy to work with the Congressman in 
making that comparison as clean as possible.
    Mr. MCCRERY. One question to Dr. Holtz-Eakin. On the 
question of whether we should write into law the premium dollar 
amount for the pharmaceutical plans, do you believe that a 
prescription drug plan, which does a very good job at 
negotiating with pharmaceutical manufacturers and others in the 
distribution chain, should have the same premium as a plan that 
doesn't do a great job in those negotiations?
    Dr. HOLTZ-EAKIN. In looking at and evaluating such a plan, 
the degree to which plans can offer different prices sends a 
clear signal to beneficiaries to pursue lower-cost plans if 
those plans also meet the other parts of their desires. To the 
extent that mechanism is available, we will facilitate cost 
containment. On the other hand, it also presents the 
possibility that different beneficiaries will face different 
prices if they reside in different regions. Those are the 
elements that we considered in looking at those plans.
    Mr. MCCRERY. If we put the dollar amount in law, the 
incentive for a plan to do a better job would go away, wouldn't 
it?
    Dr. HOLTZ-EAKIN. That is true.
    Mr. MCCRERY. Thank you. Thank you, gentlemen, very much for 
your testimony and your responses to our questions. I call the 
next panel.
    Ms. TUBBS JONES. Mr. Chairman----
    Mr. MCCRERY. If you wish, you may inquire, although you 
missed the entire hearing, you may----
    Ms. TUBBS JONES. Mr. Chairman, for the record, I did not 
miss the entire hearing. I had been here before, but I had to 
leave for another meeting.
    Mr. MCCRERY. Okay, you may inquire.
    Ms. TUBBS JONES. Just so the record is clear. I don't want 
to make a big deal, but I did hear their testimony.
    Mr. MCCRERY. You did?
    Ms. TUBBS JONES. I did hear their testimony.
    Mr. MCCRERY. According to your staff, not here at the 
beginning.
    Ms. TUBBS JONES. Well, take my word, not my staff, okay?
    Mr. MCCRERY. You may inquire.
    Ms. TUBBS JONES. Thank you, Mr. Chairman. Mr. Walker, 
earlier in your testimony today, you were talking about 
percentages with regard to GDP. Do you recall that testimony?
    Mr. WALKER. Yes, I do.
    Ms. TUBBS JONES. My question goes to, and your 
responsibility as the U.S. Comptroller General, you are looking 
at all costs in the government, not just particularly in the 
health care, as we are talking about today.
    Mr. WALKER. That is correct, among other things.
    Ms. TUBBS JONES. Among other things, yes.
    What percentage of the GDP are the dollars that we have 
expended so far in the deployment of the military, the expenses 
in terms of machinery, and so forth, and the war in Iraq? What 
percentage of the GDP is that?
    Mr. WALKER. Well, just back of the envelope, the current 
request is I think $80 billion, if I am not mistaken.
    Ms. TUBBS JONES. Correct.
    Mr. WALKER. Sixty-billion dollars for the U.S. Department 
of Defense (DOD), but I think----
    Ms. TUBBS JONES. It is $80 billion, the pack. The 
supplemental was $80----
    Mr. WALKER. The DOD was $60----
    Ms. TUBBS JONES. Right.
    Mr. WALKER. So, you take $60 billion, and the overall 
economy is, about $11 trillion. So, less than 1 percent.
    Ms. TUBBS JONES. Less than 1 percent. What percent of the 
GDP would the proposed--there is a proposal by the Democrats to 
fund a prescription drug benefit for senior citizens in 
conjunction with the existing Medicare program. Do you have any 
idea what percentage of the GDP that proposal is?
    Mr. WALKER. I am not familiar with any proposal that is on 
the table right now for a prescription drug benefit, but if you 
mean last year's, last year's was what, $900 billion, roughly, 
over 10 years?
    I don't recall how much it is per year, but if you assume 
that it was about the same per year----
    Ms. TUBBS JONES. Assume $900 billion.
    Mr. WALKER. Ninety-billion dollars, it would be less than 1 
percent of GDP.
    Mr. STARK. Would the gentle-lady yield for just a moment?
    Ms. TUBBS JONES. Absolutely.
    Mr. STARK. The $80 billion for the Defense was 6 months, 
and ours was for 12 months--our drug benefit--so I would 
suspect that you would have to----
    Mr. WALKER. We don't know what the cost is going to be. 
Frankly, I have got a son who is a company commander with the 
Marine Corps in Iraq right now. So, we don't know how long they 
are going to be there, and we don't know what the cost is going 
to be.
    Ms. TUBBS JONES. You know what, my heart goes out to you 
having a son over there. I have lost two of my constituents, 
and the point is not to argue our patriotism. What I wanted to 
bring to the attention of the Committee and to those who are 
listening is the fact that previously Secretary Snow said it 
doesn't matter what the cost of the war, it is minor in terms 
of the GDP.
    If you assume his statement is correct, and you assume that 
the 1 percent of GDP is what you are suggesting the Democratic 
plan, though you are not familiar with it, would cost, that is 
minor, compared to the GDP, to pay for the cost of a 
prescription drug benefit for all seniors. Would you agree with 
that, sir?
    Mr. WALKER. I think you are comparing apples and oranges, 
though, with all due respects.
    Ms. TUBBS JONES. What are the apples from your perspective?
    Mr. WALKER. Let me tell you why I say that. You may or may 
not agree.
    Ms. TUBBS JONES. We have a short amount of time, just so 
you know that.
    Mr. WALKER. I understand that. The cost of the war is not 
going to be forever. We are not going to be in Iraq forever. 
However, the cost of a prescription drug benefit, unless 
Congress decides to rescind that benefit, after it passes, will 
be forever.
    Ms. TUBBS JONES. I understand the forever language, but the 
people that would be covered by the prescription drug benefit 
for as long as they live. They have been forever, most of them 
paying into our--are paying taxes, and they are forever our 
people. They are our mothers, our fathers, our sisters and 
brothers, and we are going to be forever grateful to them for 
the work that they have done to allow us to be sitting where 
they are sitting today. Fair?
    Mr. WALKER. I would agree with that.
    Ms. TUBBS JONES. Thank you. Dr. Holtz-Eakin, I am sorry. I 
would have asked you a question, but I can't. I have run out of 
time. I am on yellow. At another juncture, I hope to be able to 
engage with you and ask you a few questions, and I yield back 
my time, Mr. Chairman, and I thank you for the opportunity to 
ask questions.
    Mr. MCCRERY. You are quite welcome. Thank you very much, 
gentlemen, for your testimony and your responses, and now I 
would like to call up our next panel; three Ph.D.'s, Dr. 
Stuart, Dr. Pauly and Dr. Reinhardt.
    We have testifying on our next panel--I am going to let Mr. 
Cardin introduce his constituent. Before I do that, I will say 
the other two witnesses are Dr. Uwe Reinhardt, who is a 
professor of Economics and Public Affairs, the Department of 
Economics and Woodrow Wilson School of Public and International 
Affairs at Princeton University; Dr. Mark Pauly, professor, 
Health Care Systems, the Wharton School, University of 
Pennsylvania.
    Mr. Cardin, if you would honor us with your----
    Mr. CARDIN. We are very pleased to have Dr. Bruce Stuart 
with us today from the University of Maryland School of 
Pharmacy, the Peter Lamy Center on Drug Therapy and Aging. Dr. 
Stuart has been a tremendous help for us locally, as well as 
nationally, on these issues and it is a pleasure to have him 
here for the Committee on Ways and Means.
    Mr. MCCRERY. Thank you, Mr. Cardin, and thank all of you, 
gentlemen, for appearing today. Your written testimony will be 
submitted for the record. If you could, in about 5 minutes, 
summarize your testimony, we would appreciate it. Dr. Stuart, 
we will start with you.
    [Questions submitted to Mr. Walker from Mr. Houghton, and 
his responses follow:]

    Question: I understand that historically when Congress has added a 
new benefit or when CMS makes a national coverage determination, all 
other insurance becomes secondary to Medicare regardless of whether it 
is offered through supplemental insurance, a private plan, or Medicaid. 
Is this correct? Is this coordinated sufficiently under current law and 
regulations so that all people, regardless of their coverage, 
understand the rules?

    Response: Whether Medicare would be the primary or secondary payer 
depends on the type of other coverage the beneficiary has. In general, 
Medicare is the primary payer for covered services when a Medicare 
beneficiary has any of the following sources of supplemental coverage:

      a. Medigap insurance, which is designed to supplement Medicare 
by paying certain cost-sharing requirements or non-covered services (42 
U.S.C. Sec. 1395ss),
      b. Medicaid, which statutorily is always the insurer of last 
resort (42 U.S.C. Sec. 1902(a)(25)), or
      c. employer-sponsored health coverage when the beneficiary and 
spouse are no longer employed.

    In general, Medicare is the secondary payer for covered services 
when a Medicare beneficiary is:

      a. working and has employer-sponsored group health coverage (42 
U.S.C. Sec. 1395y(b)),
      b. not working but is covered by a working spouse's employer 
group health plan,
      c. treated for a condition or an injury where a third party may 
be liable for medical services provided, or
      d. afflicted with end-stage renal disease during the 30-month 
coordination period.

    The liability for Medicare or other payers to pay for these 
services depends on coverage determinations by CMS and the plans. One 
would have to look to the terms of the other plan's coverage to 
determine how that plan's coverage will be affected by a Medicare 
decision. For example, if Medicare began covering a health care service 
for which it would be the primary payer, a beneficiary's other plan 
would either provide secondary coverage or no coverage depending on the 
terms of that plan. Alternatively, if an employer's group health 
insurance is the primary payer but does not pay in full for certain 
Medicare-covered services, Medicare may provide secondary coverage; 
however, if the group plan denies payment for these services, Medicare 
may pay as primary payer.
    Accurately determining whether Medicare is the primary or the 
secondary payer and effectively coordinating these benefits requires 
that the CMS have timely information on any other sources of health 
coverage that a beneficiary may have both at the time of initial 
eligibility for Medicare and when any changes occur. CMS provides 
information to beneficiaries and providers about coordination of 
benefits, the need to provide accurate insurance information, and 
Medicare's role as primary or secondary payer on its Web site (http://
www.cms.hhs.gov/medicare/cob/) and through other means.
    There is no question that this issue is complex and making it 
understandable to everyone is challenging. Fortunately, the number of 
instances where confusion will arise is small relative to the numbers 
of Medicare beneficiaries and services. Medicare covers a broad variety 
of services, including inpatient hospital care, skilled nursing 
facility care, certain home health and hospice care, physician and 
outpatient services, diagnostic services, outpatient physical and 
occupational therapy, ambulance services, and other medical services 
and supplies. Coverage policies impose some limitations, but such 
policies are important as they seek to assure that Medicare only pays 
for necessary valued services.

    Question: If we were to enact a drug benefit that allows employers 
the option to continue retiree coverage and tap into the Medicare drug 
subsidy, do you think it will be confusing for Medicare beneficiaries, 
especially if the ``Medicare plan(s)'' differs from the employer-
sponsored plan? For example, a beneficiary may not know who pays each 
time they go to the pharmacy (whether it is the Federal Government, 
private insurer or paid out of pocket). Obviously we need a structure 
that retirees understand, can you make recommendations on how to avoid 
confusion in layering a Medicare benefit with employer sponsored 
coverage?

    Response: I agree that it will be very important to provide 
Medicare beneficiaries with clear and comprehensive information about 
any choices they would have under a proposed Medicare drug benefit. As 
I stressed in my statement, if multiple private entities were selected 
to administer drug benefits, a means to ensure that beneficiaries 
receive comprehensive user-friendly information about policy and 
benefit differences among competing entities would be necessary. 
Similarly, such comprehensive information will be necessary to help 
beneficiaries determine how any new Medicare covered drugs would 
coordinate with existing sources of drug coverage, such as employer-
sponsored group health plans and Medigap, as well as the effect on 
beneficiaries out-of-pocket payments. Beneficiaries will need such 
information to make informed decisions regarding whether to maintain or 
opt out of current supplemental coverage--an especially important 
decision as the availability of employer-sponsored retiree health 
benefits has generally declined over the last decade and many employer-
sponsored group health plans have increased cost-sharing requirements.
    One option that you may consider to reduce confusion for Medicare 
beneficiaries maintaining employer coverage is to provide a subsidy for 
premiums of a private plan offering a drug benefit rather than having 
dual coverage through both a private plan and Medicare. Then each 
beneficiary with drug coverage would only be affected by one set of 
coverage and copayment rules. This would also avoid the situation we 
have now where supplementary insurance, like Medigap, ends up making 
beneficiaries less sensitive to the costs of services and contributes 
to the fiscal challenges the Medicare program faces today.

                                 
    [Questions submitted from Mr. Levin, Mrs. Johnson, and Mr. 
Ramstad to Mr. Holtz-Eakin and his responses follow:]

    Levin Question: Please provide a historical series of CBO's 
projections for Medicare spending over the last six or seven years.
    Response: Table 1 shows the Congressional Budget Office's (CBO's) 
projections of Medicare spending and actual Medicare spending for the 
years 1995 to 2002 (with projections extending into future years as 
applicable). The projections of ``baseline'' spending shown there for 
each 10-year period-which were made in January or March of the previous 
year-reflect current law governing Medicare at that time. Actual 
spending will differ from projections for a variety of reasons, 
including subsequent changes in legislation or in the underlying 
economy. For example, the projections of Medicare spending made prior 
to the passage of the Balanced Budget Act of 1997 were substantially 
higher than the projections made after that point.

    Johnson Question: As a supplement to the chart on long-term 
Medicare spending included in your testimony, please show the effect of 
adding prescription drug benefits at varying levels (with 10-year costs 
of $500 billion to $1 trillion).
    Response: Table 2 shows how Medicare spending as a share of gross 
domestic product (GDP) would vary depending on the size of the10-year 
drug benefit that was enacted. As the table indicates, Medicare 
spending in 2075 could range from 9.2 percent of GDP under current law 
to 12.5 percent if a drug benefit costing $1 trillion over 10 years was 
enacted today. The estimates incorporate the assumption that drug 
spending outside of the 10-year budget window will grow with the rest 
of Medicare (as a share of GDP). That assumption is preliminary and 
subject to review, and considerable uncertainty surrounds any 
projection made over such a long period.

    Ramstad Question: Please provide estimates of GDP and Medicare 
spending in 2075 in nominal dollars.
    Response: Nominal GDP in 2075 will be $293 trillion, and Medicare 
transfers will total $27 trillion, according to CBO's preliminary 
projections. Because such figures are difficult to compare with current 
levels of spending and economic output, the estimated share of GDP 
devoted to Medicare spending-in 2075, 9.2 percent-can be a more useful 
metric.


            Table 1.--Medicare Baseline Actuals and Projections, 1995 to 2013 (Actuals shown in bold)
----------------------------------------------------------------------------------------------------------------
           Fiscal Year             1995    1996    1997    1998    1999    2000    2001    2002    2003    2004
----------------------------------------------------------------------------------------------------------------
March 1996
----------------------------------------------------------------------------------------------------------------
Benefits                           176.9   195.8   215.3   236.2   257.2   279.3   303.1   328.4   356.9   388.9
----------------------------------------------------------------------------------------------------------------
Premiums                            20.2    20.0    20.6    22.6    24.0    25.1    26.2    27.4    28.6    30.0
----------------------------------------------------------------------------------------------------------------
  Net Benefits                     156.7   175.8   194.7   213.6   233.2   254.2   276.8   301.0   328.3   358.9
----------------------------------------------------------------------------------------------------------------

----------------------------------------------------------------------------------------------------------------
Jan 1997
----------------------------------------------------------------------------------------------------------------
Benefits                                   191.0   207.9   226.0   247.1   271.8   284.4   312.4   337.9   366.8
----------------------------------------------------------------------------------------------------------------
Premiums                                    20.0    20.2    21.4    22.4    23.4    24.5    25.6    26.7    28.0
----------------------------------------------------------------------------------------------------------------
  Net Benefits                             171.0   187.7   204.6   224.6   248.3   259.9   286.8   311.2   338.8
----------------------------------------------------------------------------------------------------------------

----------------------------------------------------------------------------------------------------------------
Jan 1998
----------------------------------------------------------------------------------------------------------------
Benefits                                           207.0   216.6   229.6   242.2   266.0   275.5   304.1   328.9
----------------------------------------------------------------------------------------------------------------
Premiums                                            20.4    20.9    22.8    25.2    28.0    31.1    34.6    38.5
----------------------------------------------------------------------------------------------------------------
  Net Benefits                                     186.6   195.8   206.8   217.0   238.1   244.5   269.5   290.5
----------------------------------------------------------------------------------------------------------------

----------------------------------------------------------------------------------------------------------------
March 1999
----------------------------------------------------------------------------------------------------------------
Benefits                                                   210.1   212.1   227.6   243.1   253.2   277.1   298.5
----------------------------------------------------------------------------------------------------------------
Premiums                                                    20.8    21.5    23.2    25.4    27.7    30.6    34.1
----------------------------------------------------------------------------------------------------------------
  Net Benefits                                             189.4   190.6   204.4   217.7   225.5   246.5   264.4
----------------------------------------------------------------------------------------------------------------

----------------------------------------------------------------------------------------------------------------
March 2000
----------------------------------------------------------------------------------------------------------------
Benefits                                                           208.3   216.9   234.8   242.4   262.9   282.1
----------------------------------------------------------------------------------------------------------------
Premiums                                                            21.6    21.8    23.3    25.4    28.1    31.1
----------------------------------------------------------------------------------------------------------------
  Net Benefits                                                     186.7   195.1   211.5   217.0   234.8   251.0
----------------------------------------------------------------------------------------------------------------

----------------------------------------------------------------------------------------------------------------
March 2001
----------------------------------------------------------------------------------------------------------------
Benefits                                                                   214.9   237.0   251.4   268.5   288.0
----------------------------------------------------------------------------------------------------------------
Premiums                                                                    21.9    23.6    26.9    30.0    33.3
----------------------------------------------------------------------------------------------------------------
  Net Benefits                                                             193.0   213.4   224.5   238.5   254.7
----------------------------------------------------------------------------------------------------------------

----------------------------------------------------------------------------------------------------------------
March 2002
----------------------------------------------------------------------------------------------------------------
Benefits                                                                           236.5   246.9   259.4   272.7
----------------------------------------------------------------------------------------------------------------
Premiums                                                                            23.7    25.9    27.8    29.7
----------------------------------------------------------------------------------------------------------------
  Net Benefits                                                                     212.7   221.0   231.6   243.1
----------------------------------------------------------------------------------------------------------------

----------------------------------------------------------------------------------------------------------------
March 2003
----------------------------------------------------------------------------------------------------------------
Benefits                                                                                   252.2   271.3   285.7
----------------------------------------------------------------------------------------------------------------
Premiums                                                                                    26.0    28.3    31.6
----------------------------------------------------------------------------------------------------------------
  Net Benefits                                                                             226.2   243.1   254.1
----------------------------------------------------------------------------------------------------------------



                  Table 1.--Medicare Baseline Actuals and Projections, 1995 to 2013 (Continued)
----------------------------------------------------------------------------------------------------------------
               Fiscal Year                 2005    2006    2007    2008    2009    2010    2011    2012    2013
----------------------------------------------------------------------------------------------------------------
March 1996
----------------------------------------------------------------------------------------------------------------
Benefits                                   424.0   463.0
----------------------------------------------------------------------------------------------------------------
Premiums                                    31.1    32.1
----------------------------------------------------------------------------------------------------------------
  Net Benefits                             393.0   430.9
----------------------------------------------------------------------------------------------------------------

----------------------------------------------------------------------------------------------------------------
Jan 1997
----------------------------------------------------------------------------------------------------------------
Benefits                                   408.4   436.2   462.6
----------------------------------------------------------------------------------------------------------------
Premiums                                    29.3    30.7    32.3
----------------------------------------------------------------------------------------------------------------
  Net Benefits                             379.1   405.5   430.4
----------------------------------------------------------------------------------------------------------------
Jan 1998
----------------------------------------------------------------------------------------------------------------
Benefits                                   365.6   375.3   415.4   447.0
----------------------------------------------------------------------------------------------------------------
Premiums                                    42.4    46.4    50.6    55.1
----------------------------------------------------------------------------------------------------------------
  Net Benefits                             323.3   329.0   364.7   391.9
----------------------------------------------------------------------------------------------------------------
March 1999
----------------------------------------------------------------------------------------------------------------
Benefits                                   328.4   343.0   377.8   409.5   442.9
----------------------------------------------------------------------------------------------------------------
Premiums                                    37.6    40.4    44.4    48.7    53.1
----------------------------------------------------------------------------------------------------------------
  Net Benefits                             290.8   302.5   333.4   360.8   389.8
----------------------------------------------------------------------------------------------------------------
March 2000
----------------------------------------------------------------------------------------------------------------
Benefits                                   308.4   318.7   347.8   373.4   401.7   432.5
----------------------------------------------------------------------------------------------------------------
Premiums                                    34.2    37.2    40.3    43.6    47.2    51.0
----------------------------------------------------------------------------------------------------------------
  Net Benefits                             274.2   281.5   307.5   329.8   354.5   381.5
----------------------------------------------------------------------------------------------------------------
March 2001
----------------------------------------------------------------------------------------------------------------
Benefits                                   313.7   331.7   360.6   389.1   420.3   454.2   499.3
----------------------------------------------------------------------------------------------------------------
Premiums                                    36.8    39.6    43.4    47.1    50.9    55.3    60.4
----------------------------------------------------------------------------------------------------------------
  Net Benefits                             276.9   292.1   317.2   342.0   369.4   398.9   438.9
----------------------------------------------------------------------------------------------------------------
March 2002
----------------------------------------------------------------------------------------------------------------
Benefits                                   293.1   308.5   335.0   361.2   389.0   418.9   454.1   482.7
----------------------------------------------------------------------------------------------------------------
Premiums                                    32.1    35.0    38.6    42.1    45.8    49.6    53.8    58.2
----------------------------------------------------------------------------------------------------------------
  Net Premiums                             261.0   273.5   296.4   319.1   343.2   369.3   400.3   424.5
----------------------------------------------------------------------------------------------------------------
March 2003
----------------------------------------------------------------------------------------------------------------
Benefits                                   305.0   317.6   341.2   364.6   390.9   419.4   453.6   480.2   522.0
----------------------------------------------------------------------------------------------------------------
Premiums                                    34.4    37.1    40.0    43.1    46.5    50.4    54.6    59.1    64.4
----------------------------------------------------------------------------------------------------------------
  Net Benefits                             270.6   280.5   301.2   321.5   344.4   369.0   399.0   421.1   457.7
----------------------------------------------------------------------------------------------------------------



 Table 2.--Medicare Transfers as a Percentage of GDP Under Current Law and Various Scaled Drug Benefit Packages
                                     (Reflecting CBO's Spring 2003 Baseline)
----------------------------------------------------------------------------------------------------------------
                                             Spending Under a Drug Benefit with Costs over the 2006-2013 Period
                                                                             of:
      Calendar Year         Spending Under ---------------------------------------------------------------------
                             Current Law      $400      $500      $600      $700      $800      $900       $1
                                             Billion   Billion   Billion   Billion   Billion   Billion  Trillion
----------------------------------------------------------------------------------------------------------------
2005                                  2.4        2.5       2.5       2.5       2.5       2.5       2.5       2.5
----------------------------------------------------------------------------------------------------------------
2010                                  2.6        2.9       3.0       3.1       3.2       3.2       3.3       3.4
----------------------------------------------------------------------------------------------------------------
2015                                  3.0        3.4       3.5       3.6       3.7       3.8       3.9       4.0
----------------------------------------------------------------------------------------------------------------
2020                                  3.4        3.9       4.0       4.1       4.3       4.4       4.5       4.6
----------------------------------------------------------------------------------------------------------------
2025                                  4.0        4.6       4.7       4.9       5.0       5.1       5.3       5.4
----------------------------------------------------------------------------------------------------------------
2030                                  4.7        5.4       5.5       5.7       5.8       6.0       6.2       6.3
----------------------------------------------------------------------------------------------------------------
2035                                  5.3        6.1       6.2       6.4       6.6       6.8       6.9       7.1
----------------------------------------------------------------------------------------------------------------
2040                                  5.8        6.6       6.8       7.0       7.2       7.4       7.6       7.8
----------------------------------------------------------------------------------------------------------------
2045                                  6.1        7.0       7.2       7.4       7.6       7.8       8.0       8.3
----------------------------------------------------------------------------------------------------------------
2050                                  6.5        7.4       7.6       7.8       8.1       8.3       8.5       8.7
----------------------------------------------------------------------------------------------------------------
2055                                  6.9        7.9       8.1       8.3       8.6       8.8       9.1       9.3
----------------------------------------------------------------------------------------------------------------
2060                                  7.4        8.5       8.7       8.9       9.2       9.5       9.7      10.0
----------------------------------------------------------------------------------------------------------------
2065                                  7.9        9.1       9.4       9.6       9.9      10.2      10.5      10.8
----------------------------------------------------------------------------------------------------------------
2070                                  8.6        9.9      10.1      10.4      10.7      11.0      11.3      11.6
----------------------------------------------------------------------------------------------------------------
2075                                  9.2       10.6      10.9      11.2      11.5      11.8      12.1      12.5
----------------------------------------------------------------------------------------------------------


                                 

STATEMENT OF BRUCE STUART, PH.D., PROFESSOR AND DIRECTOR, PETER 
 LAMY CENTER ON DRUG THERAPY AND AGING, UNIVERSITY OF MARYLAND 
            SCHOOL OF PHARMACY, BALTIMORE, MARYLAND

    Dr. STUART. Thank you, Mr. Chairman, and Members of the 
Committee. I would like to use my brief remarks to address what 
I think is the most important question underlying the debate 
over a Medicare drug benefit, which is what will happen to 
beneficiaries if Congress fails to act. I hope to show you that 
recent trends in coverage put future beneficiaries at risk of 
having significantly reduced options for meaningful 
prescription benefits if legislative action is not taken soon.
    Although a higher proportion of beneficiaries had some form 
of prescription coverage in 2000 than ever before, the growth 
is unsustainable. It is due to two phenomena, a rise in 
Medicare HMO enrollments and a rapidly growing segment of 
beneficiaries with ill-defined and overlapping benefits.
    In fact, since 1995, there has been a slight decline in 
rates of drug coverage among beneficiaries who rely on a single 
prescription plan from an employer, a Medigap policy, Medicaid 
or other public program. By examining changes in these sources 
of coverage, we can develop a reasonably accurate forecast of 
what beneficiaries will face in the near future.
    Retiree health benefits offered by employers and unions 
represent the most generous private source of prescription 
coverage available to Medicare beneficiaries. Data from the 
MCBS show that the number of beneficiaries with prescription 
coverage from employer plans has remained steady at 34 percent 
from 1996 through the latest data release for 2000.
    This is actually a very surprising statistic, in light of 
the pull-back in retiree health benefits reported by employers. 
According to annual Mercer/Foster Higgins surveys, the number 
of large employers offering employer coverage has dropped from 
57 percent in 1987 to just 23 percent in 2001.
    Why haven't we seen a comparable decline in the MCBS data? 
Preliminary results from a study my colleagues and I are 
conducting for the Commonwealth Fund suggests that the answer 
lies in beneficiary demographics. We find that the proportion 
of younger beneficiaries with employee-sponsored health 
benefits dropped dramatically between 1996 and 2000, while 
there was a small increase in coverage for beneficiaries 70 and 
older. This pattern does not auger well for future retirees.
    The advent of Medicare+Choice in 1997 was followed by a 
major expansion in HMO enrollments. At the program's peak in 
1999, more than 7.5 million beneficiaries had enrolled, yet 22 
percent of them left their plans that year, presumably for 
better coverage elsewhere.
    The HMO enrollees represent a large fraction of the 
beneficiary population with shifting sources of prescription 
benefits and gaps in coverage. Today, M+C enrollment has 
declined by a quarter and the drug coverage offered by the 
remaining plans is less generous than it was 4 years ago.
    Beyond M+C and employer coverage, the only other private 
source of prescription benefits available to beneficiaries is 
self-purchased coverage through a Medigap plan. In most States 
private carriers are permitted to offer three standardized 
plans with very limited benefit provisions that have not been 
updated in over a decade. Even this limited coverage may appeal 
to older people who have no other options.
    The catch is that many carriers do not sell these policies 
and those that do generally charge high premiums. In some 
cases, the premiums exceed the maximum value of the 
prescription coverage itself. In other words the market for 
Medigap plans is ill-equipped to provide meaningful coverage to 
Medicare beneficiaries who lose benefits because of pull-backs 
in HMOs and employer plans.
    The poorest elderly typically do not qualify for employer-
sponsored health insurance and cannot afford the premiums for 
individual Medigap policies. Medicaid is available to those who 
meet stringent Federal and State means tests for income and 
assets. Some States have responded to the needs of those too 
poor to afford adequate medications, but not poor enough to 
qualify for traditional Medicaid by extending full Medicaid 
coverage to beneficiaries enrolled in the Federal Qualified 
Medicare Beneficiaries and Specified Low-Income Medicare 
Beneficiary programs.
    Thirty other States have enacted pharmaceutical assistance 
programs that subside prescription drug expenses for selected 
low-income populations. The latest development is the CMS 
Pharmacy Plus waiver program that encourages States to develop 
drug-assistance plans paid for through savings in traditional 
Medicaid. Five States have approved Pharmacy Plus Programs and 
10 others are in the process of developing waiver applications.
    This flurry of activity at the State level might lead one 
to conclude that the needs of low-income Medicare beneficiaries 
are being adequately addressed. That would be a mistake. 
According to the MCBS, less than half of beneficiaries below 
the Federal poverty level are enrolled in Medicaid or another 
public program offering drug benefits during 2000. Only 1 in 5 
beneficiaries, between 100 and 150 percent of the poverty line, 
was enrolled in a public plan.
    The current patchwork of State programs is extremely 
fragile. Four of the 30 States that enacted pharmaceutical 
assistance programs have put them on indefinite hold because of 
budgetary problems. Massachusetts has frozen enrollments in its 
assistance plan. Some of the larger plans, including the 
Pennsylvania Program of All-Inclusive Care for the Elderly 
program are seriously underfunded.
    Let me rephrase the central question I posed at the 
beginning of my remarks. What should Congress learn from these 
recent trends as it prepares to enact a meaningful drug 
benefit? The first lesson is that strong action must be taken 
to avoid further erosion in retiree health benefits. 
Subsidizing prescription coverage will reduce the burden on 
employers, but additional steps will be necessary to assure 
that firms maintain or, better yet, improve upon current 
coverage.
    Second, while managed care plans have clearly failed to 
provide meaningful drug benefits in the absence of government 
payment, it is just possible that covering drug costs in plan 
capitation rates may actually save the M+C program.
    Finally, as important as State programs can be in filling 
the gaps in prescription coverage, present circumstances call 
for a unified national program of prescription benefits 
available to all Medicare beneficiaries.
    Thank you very much.
    [The prepared statement of Dr. Stuart follows:]

 Statement of Bruce Stuart, Ph.D., Professor and Director, Peter Lamy 
 Center on Drug Therapy and Aging, University of Maryland, Baltimore, 
                                Maryland

    Mr. Chairman and distinguished Members of the House Ways and Means 
Committee. My name is Bruce Stuart. I am a Professor at the University 
of Maryland School of Pharmacy. I also direct the Peter Lamy Center on 
Drug Therapy and Aging which conducts research on Medicare 
beneficiaries' drug coverage, utilization, and outcomes. I am pleased 
to be here this morning to address what I believe should be the core 
question underlying the debate over a Medicare drug benefit; namely, 
what will happen to beneficiaries if Congress fails to act? I will show 
that recent trends in coverage put future beneficiaries at risk of 
having significantly reduced options for meaningful prescription 
benefits if legislative action is not taken soon.
    First, the good news. The latest data from the Medicare Current 
Beneficiary Survey (MCBS) show that a higher proportion of 
beneficiaries had some form of prescription coverage in 2000 than ever 
before, reaching almost 79% of the beneficiary population with Medicare 
entitlement for the entire year. That is up from 69% in 1995. Moreover, 
a higher percentage of those with drug benefits in 2000 maintained them 
throughout the year than in any previous year for which we have data.
    However, aggregate statistics can be misleading. The growth in 
prescription coverage between 1995 and 2000 is explained by two 
phenomena, a rise in Medicare HMO enrollment and a rapidly growing 
segment of beneficiaries with ill-defined and overlapping benefits. 
There was a slight decline in rates of prescription coverage among 
beneficiaries who relied on a single prescription plan from an 
employer, a Medigap policy, Medicaid, or other public program. By 
examining changes in these sources of prescription coverage, we can 
develop a reasonably accurate forecast of what beneficiaries will face 
in the near future.
    Supplemental health benefits offered by employers and unions 
represent the most generous private source of prescription coverage 
available to Medicare beneficiaries. No one knows exactly how many 
beneficiaries are entitled to employer-sponsored coverage. Not all 
retirees given the opportunity of health insurance choose to take it 
either because of cost or alternative coverage. Data from the MCBS show 
that the number of beneficiaries with employer-sponsored health plans 
peaked in 1997 at 41% of the population and fell slightly to 39% in 
2000. The proportion of beneficiaries with prescription coverage under 
employer plans has remained a steady 34% from 1995 through the latest 
data release for 2000. These are actually very surprising statistics in 
light of the pull-back in retiree health benefits reported by 
employers. According to annual Mercer/Foster Higgins surveys, the 
number of large employers offering health coverage to Medicare-eligible 
retirees declined from 57 percent in 1987 to 23 percent in 2001. Why 
haven't we seen a comparable decline in the MCBS data? Preliminary 
results from a study my colleagues and I are conducting for The 
Commonwealth Fund suggest that the answer lies in beneficiary 
demographics. Younger beneficiaries aged 65 to 69 are more likely to be 
affected by changing employer policies on retirement benefits than 
beneficiaries aged 70 and older. Based on MCBS data, we found that the 
proportion of beneficiaries with employer-sponsored health benefits in 
the younger age band dropped dramatically between 1995 and 2000, while 
there was a small increase in coverage for the older group. This 
pattern does not auger well for future retirees.
    The advent of Medicare+Choice in 1997 was followed by a major 
expansion in HMO enrollments. At the program's peak in 1999, more than 
seven and a half million beneficiaries had enrolled. Yet 22 percent of 
them left their plans that year, presumably to get better coverage 
elsewhere. HMO enrollees represent a large fraction of the beneficiary 
population with shifting sources of prescription benefits and gaps in 
coverage. For example, 50% of those who disenrolled from an M+C plan in 
1999 were left without prescription coverage. But even among those who 
stayed, only 65% were able to rely on M+C prescription coverage alone; 
20% supplemented HMO drug benefits with other coverage, 7% had outside 
drug coverage and no M+C prescription benefits, and 9% had no 
prescription benefits from any source. Today, M+C enrollment has 
declined by a quarter, and the drug coverage offered by the remaining 
plans is far less generous than four years ago. Federal lock-in rules 
now scheduled for 2005 will presumably reduce the rate of M+C turnover, 
but that will not address the underlying reasons why beneficiaries move 
from plan to plan. Indeed, limiting beneficiaries' ability to leave 
plans that no longer meet their needs will make them worse off, and may 
well lead to further erosion in M+C enrollments. Plan withdrawals and 
rising premiums will have a similar effect.
    Beyond M+C and employer coverage, the only other private source of 
prescription benefits available to Medicare beneficiaries is self-
purchased coverage through a Medigap plan. In most States, private 
carriers are permitted to offer three standardized plans (H, I, and J) 
with maximum prescription coverage of $1,250 or $3,000 per year. All 
three plans contain a $250 deductible and 50% coinsurance. These 
benefit provisions were created by Federal law over a decade ago, and 
have not been updated. But even this limited coverage may appeal to 
older people who have no other options. The catch is that many carriers 
do not sell the policies that cover drugs, and those that do generally 
charge high premiums that in some cases actually exceed the maximum 
value of the coverage itself. According to MCBS data, the proportion of 
non-institutionalized beneficiaries relying only on these policies 
hovered around 9% between 1995 through 2000 (another percent or two 
mixed self-purchased plans with other coverage). The real number may be 
only half that high. Most experts believe that beneficiary reports of 
self-purchased drug coverage are inflated with the inclusion of 
discount cards and other plans that do not provide true insurance. 
Whatever the real number, the market for Medigap plans is ill equipped 
to provide meaningful coverage to Medicare beneficiaries who lose 
benefits because of pull-backs in HMOs and employer plans.
    The poorest elderly typically do not qualify for employer-sponsored 
health insurance and can't afford premiums for individual Medigap 
policies. Medicaid is available to those who meet Federal and State 
means tests for income and assets. Dual enrollment in Medicare and 
Medicaid dropped slowly throughout the nineteen-nineties as a result of 
rising beneficiary incomes and static income-eligibility criteria. A 
slight up tick in 2000 may signal a reversal in this trend, but 
traditional Medicaid is still available only to the poorest poor. Some 
states have responded to the needs of those too poor to afford adequate 
medications but not poor enough to qualify for traditional Medicaid by 
extending full Medicaid benefits, including prescription coverage, to 
Medicare beneficiaries enrolled in the Federal QMB and SLMB programs. 
Other States (30 as of this writing) have enacted pharmaceutical 
assistance programs that subsidize drug expenses for selected low-
income populations. An additional eight States have drug discount card 
programs for Medicare beneficiaries. The latest development is the CMS 
``Pharmacy Plus'' waiver program that encourages States to develop drug 
assistance plans paid for through savings in traditional Medicaid. Five 
States (Illinois, Wisconsin, South Carolina, Florida, and Maryland) 
have approved Pharmacy Plus programs. Ten others are in the process of 
developing waiver applications.
    This flurry of activity at the State level might lead one to 
conclude that low-income Medicare beneficiaries' needs for drug 
coverage are being adequately addressed. That would be a mistake. 
According to the MCBS, 48% of beneficiaries below the Federal poverty 
line were enrolled in Medicaid or another public program offering drug 
benefits during 2000. Only 20% of beneficiaries in the band between 
100% and 150% of the poverty line were enrolled in a public plan. These 
proportions are not significantly higher than in 1995 when 46% and 18%, 
respectively, received such benefits. When data become available for 
2001 and 2002, we may find that matters have improved. But even if that 
proves true, the current patchwork of State programs is extremely 
fragile. Four of the 30 States that have enacted pharmaceutical 
assistance programs have put them on indefinite hold because of 
budgetary problems. Massachusetts has frozen enrollment in its 
assistance program. Some of the largest plans, including the 
Pennsylvania PACE program are seriously under funded. The initial 
excitement surrounding the Pharmacy Plus program has turned to concern 
as States try to figure out how to pay for their new obligations 
without gutting traditional Medicaid. Unlike the Federal Government, 
State prohibitions against running budget deficits mean that assistance 
programs are most vulnerable to cuts at precisely the time they are 
most needed.
    Let me rephrase the central question I posed at the beginning: What 
should Congress learn from these recent trends as it prepares to enact 
a meaningful Medicare drug benefit? My optimism is based on the belief 
that our government will simply not permit the gains in drug coverage 
won by Medicare beneficiaries during the nineteen-nineties to be 
needlessly lost. The first lesson is that strong action must be taken 
to avoid further erosion in retiree health benefits. Subsidizing 
prescription coverage will reduce the burden on employers, but 
additional steps will be necessary to assure that firms maintain--or 
better yet--improve upon current coverage. Second, while managed care 
plans have clearly failed to provide meaningful drug benefits in the 
absence of government payment, it is just possible that including drug 
costs in plan capitation rates may actually save the M+C program. 
Finally, as important as State programs can be in filling gaps in 
prescription coverage, present circumstances call for a unified 
national program of prescription benefits available to all Medicare 
beneficiaries.
    Thank you.

                                 

    Mr. MCCRERY. Dr. Pauly?

   STATEMENT OF MARK V. PAULY, PH.D., PROFESSOR, HEALTH CARE 
     SYSTEMS, WHARTON SCHOOL, UNIVERSITY OF PENNSYLVANIA, 
                   PHILADELPHIA, PENNSYLVANIA

    Dr. PAULY. Thank you, Mr. Chairman and Members of the 
Committee. I have directed my prepared remarks at the issue of 
prescription drug coverage, but I would be happy to comment on 
the general issue of Medicare reform.
    The absence of outpatient prescription drug coverage for 
the quarter to a third of Medicare beneficiaries who don't get 
such coverage poses for them a serious risk of both high out-
of-pocket payments and the risk that they will fail to use 
drugs that are effective for their health and so be of concern 
to their fellow citizens. Are there ways to improve the 
situation?
    I believe that there are and that the best design for 
improvement that pays attention to the budget constraints for 
Medicare as a whole is one that builds on two important 
principles of public policy. First, that protection against 
financial risk should be based on a correct theory of insurance 
and, second, that coverage of concern for public policy should 
help people with low incomes pay for drugs they might otherwise 
forego, but that concern need not extend to beneficiaries with 
lower levels of spending and higher incomes who are able to pay 
for their drugs.
    I, first, consider the design of insurance coverage to 
maximize value. That is what we are trying to do here. This 
design is based on the common-sense principle that underlies 
all insurance. The purpose of insurance is to provide benefits 
when they are most needed.
    For the financial protection dimension of insurance, it is 
obvious that benefits are most needed when losses are greatest, 
since in such cases the threat to wealth and future standard of 
living is greatest. In contrast, insurance coverage is of low 
value, if it pays for low or below-average levels of expense. 
Since insurance itself always carries an administrative cost, 
such budgetable expenses usually should not be insured at the 
real cost of using resources to review claims and write checks.
    Insurance is supposed to pay for the rare high-cost event 
that spells financial disaster and not for the modest expense 
most people could reasonably expect year-after-year and could 
afford if it did occur. Insurance which did pay for small, 
predictable expenses would be insurance in name only. For the 
Medicare population, it would be roughly equivalent to an 
increase in Social Security payments, but made in a less 
transparent and less-efficient way.
    What about people who, because of the absence of insurance, 
failed to use beneficial care? We know for certain that the 
volume of drug use and drug spending is increased when 
insurance coverage is greater. This phenomenon of moral hazard 
mentioned earlier occurs for people at all income levels. In 
effect, insurance makes expensive drugs look cheap and 
inexpensive drugs look dirt cheap.
    This lower price appears to have an amazingly strong effect 
on everyone's behavior. For example, our research indicated 
that lowering the copayment for prescription from $10 to $2 
could produce up to a 65-percent increase in drug expenditure 
for people under age 65 who are middle class, privately 
insured, and the same order of magnitude is probably true for 
seniors.
    The evaluation, of course, of the increase in spending is 
uncertain. Some portion of it represents increase in spending 
that would receive social approbation. Other portions though, 
may represent the use of products which, even if of positive 
value, were not really worth what they cost.
    These two principles can be made highly consistent if we 
assume that lower income is associated with a lower use of 
drugs, other things equal, and that such low use is a matter of 
social concern. Then, the socially optimal coverage policy in a 
budget constraint world would provide virtually complete 
financial protection for those beneficiaries with incomes just 
above the Medicaid limit.
    In contrast, for the elderly middle class, who are about 
half of the elderly, the insurance of concern to government 
should cover expenses more generously as expenses rise, but 
should provide no coverage for small expenses, with the point 
of which coverage begins to take effect related to household 
income and wealth. A very simple version of such a scheme would 
involve insurance that provides full coverage of a deductible, 
with the deductible stated as a percentage of household income.
    There are two objections to this simple, but powerful 
model:
    First, because drug expenditures are not evenly spread over 
the population, some people criticize this model because most 
people will not collect from their insurance, but will either 
have to pay something or, even if the insurance is fully paid 
by taxes, will be miffed at not getting an equal slice of 
government largesse.
    As suggested earlier, if those unlucky people who have low 
drug expenses in a given time period need to receive a 
political payoff, providing low deductible or first-dollar 
coverage is an inefficient and inequitable (to those with zero 
expenses) way to do so; just increase Social Security with a 
cost of living adjustment that includes drug spending as a 
component.
    Of course, whether low risks are in or out, a somewhat more 
respectable argument is one that views front-end coverage as a 
way of dealing with adverse selection. The main problem with 
the argument here is that adverse selection only helps the high 
risks if the low risks can be induced to pay more than the 
value of their benefits, but because the benefits for low risk 
are so small and so predictable, there is very little 
willingness to pay extra.
    I will also make just a few comments on how to pay for 
drugs. I have talked about the form of insurance coverage. The 
general principle of insurance here is pretty straightforward. 
The idea would be to pay an indemnity benefit that would cover 
products that are sold in competitive markets, and that might 
be a reasonable principle for generic drugs, although the 
Federal Trade Commission should continue to be vigilant about 
pricing of those products.
    The most serious problem arises, however, for products 
protected by patents. Society offers patents in order to induce 
drug firms to invest in research & development for new 
products. Once products are invented and fixed costs have been 
incurred, however, it is desirable to get final selling prices 
down. So, our choice, actually, is between cheap products now 
and good products later, but not between cheap, good products 
now and cheap, good products later.
    Thus, the part of the government that wants to contain 
medical costs is at war with the part that wants to foster 
medical progress. It is certain that if research & development 
is undertaken by rational profit-maximizing firms, lower 
prospective prices and payments will mean fewer good, new 
products. The key, obviously, is what are the nature of the 
good products that would be foregone. They would probably 
include orphan drugs and some things of substantial value.
    In the face of such uncertainty about what public policy 
might affirmatively do, in my judgment, the best policy is to 
try again to replicate as much as possible markets with patents 
that are otherwise competitive. This situation would be best 
accomplished if individuals could choose from a large number of 
different health plans, with the plans having different 
policies as to which drugs they pay for, what prices they pay 
and what advice and assistive services they provide.
    When there is a choice of plans, those plans must be 
allowed to differ in both coverage policies and premiums paid 
by the insured for choice to be meaningful. It does not help if 
there are multiple contractors administering exactly the same 
coverage at the same beneficiary premium.
    Competition between different plans cannot be guaranteed to 
yield lowest possible price, I think it is important to 
emphasize, but it probably will lead to the best price and the 
best tradeoff between price and quality that reflects the 
tradeoffs beneficiaries are willing to make between the 
different types of cost containment that provides incentives to 
squeeze out any insurer profit and that best deals with 
government-granted patent monopolies.
    My final comment, and in some ways saving the worst for 
last or, in some ways, the best for last, we know that the 
primary reason why health care costs rise in this country is 
because of the addition of beneficial, but costly, new 
technology. I think there are serious doubts about our ability 
to afford, certainly for public programs, and perhaps even 
privately, the rate of growth of beneficial, but new, 
technology that we have become used to over time. We live and 
will live in a world of limited resources, some technology 
should not be made available to all who will benefit from it, 
but we have found no institutional structure for saying, 
``No.'' There is no institutional structure for making such 
cost-benefit tradeoffs and especially not for government-funded 
coverage like Medicare.
    So, three policy questions remain:
    First, how low a deductible at any given income level 
represents the appropriate combination of financial protection 
for seniors, appropriate incentives to use, but not overuse, 
drugs, and tax burdens on present and future taxpayers?
    Second, what tradeoffs should we make between inexpensive 
drugs today and better drugs for the future?
    Third, and most importantly, what rate of increase in 
spending for higher quality, but more costly, products we think 
is appropriate for the growing number of elders in our country?
    Thank you very much.
    [The prepared statement of Dr. Pauly follows:]
  Statement of Mark V. Pauly, Ph.D., Professor, Health Care Systems, 
 Wharton School, University of Pennsylvania, Philadelphia, Pennsylvania
    The absence of outpatient prescription drug coverage for those non-
poor Medicare beneficiaries who did not have a job at a firm that 
offered drug coverage as a retirement benefit leaves a serious gap. 
This gap exposes a quarter to a third of beneficiaries to the risk of 
high out of pocket payments for drugs or to the risk that they will 
underuse drugs that are effective for their health, and so be a concern 
to their fellow citizens. Unsubsidized Medigap markets, required to 
undertake some community rating, are plagued with adverse selection 
because high prescription drug expenses are usually associated with 
chronic conditions with highly predictable drug expenses and consequent 
severe adverse selection. Are there ways to improve this situation?
    I believe that there are, and that the best design for improvement 
is one that is built on what (in my view) ought to be two important 
principles of public policy: (1) protection against financial risk 
should be based on a correct theory of insurance, and (2) coverage of 
concern for public policy should help people with low incomes pay for 
drugs they might otherwise forego, but that concern need not extend to 
beneficiaries with lower levels of spending who are able to pay for 
their drugs. I will elaborate on the implications of these two 
principles, and then suggest what they imply for practical benefits 
design and realistic public policy. Throughout, I will be sensitive to 
a third important aspect of public policy: even current levels of 
Medicare benefit are threatened, once the baby boom generation reaches 
retirement age, by high Medicare costs relative to levels of support at 
current tax rates; the feasibility of substantial increases in the 
distortive taxes paid for Medicare (largely by younger workers) is 
limited and therefore any new benefit should add as little as possible 
to the tax burden. Drug benefits for some parts of the Medicare 
population in some circumstances are of sufficient value to justify 
some increase in payment and taxes, but these increases should be kept 
as modest as possible.
    I first consider the design of insurance coverage to maximize 
value. This design is based on the common sense principle which 
underlies all insurance. The purpose of insurance is to provide 
benefits when they are most needed. For the financial protection 
dimension of insurance, it is obvious that benefits are most needed 
when losses are greatest, since in such cases the threat to wealth and 
future standards of living is greatest. In contrast, insurance coverage 
is of low value if it pays for low (below-average) levels of expenses; 
since insurance itself always carries an administrative cost, such 
budgetable expenses usually should not be insured at the real cost of 
using resources to review claims and write checks. Insurance is 
supposed to pay for the rare high cost event that spells financial 
disaster, and not for the modest expense most people could reasonably 
expect year after year, and could afford if it did occur. Insurance 
which did pay for such smaller predictable expenses would be insurance 
in name only; it would really be an income transfer (largely 
equivalent, for this population, to an increase in Social Security 
payments), but done in a less transparent and less efficient way. Put 
more explicitly, the rational and valuable insurance is coverage 
against financial catastrophes, and only such coverage is warranted on 
the basis of financial protection.
    What about the role of insurance as assistance to people who 
otherwise would not choose to obtain beneficial care? We know for 
certain that the volume of drug use and drug spending is increased when 
coverage is greater; this phenomenon occurs for people at all income 
levels. In effect, insurance makes expensive drugs look less expensive, 
and inexpensive drugs look dirt cheap; this lower price appears to have 
an amazingly strong impact on everyone's behavior. For example, 
research indicates that lowering the copayment per prescription from 
$10 to $2 can produce a 65 percent increase in drug expenditure for 
privately insured middle class non-elderly, and the same is probably 
true for seniors.
    While the increase in use with coverage is certain, the social 
evaluation of this increase is uncertain. It may represent the use of 
highly beneficial drugs that reduce illness, frailty, and poor 
functional status about which there is substantial concern by others in 
the community. On the other hand, especially for beneficiaries who are 
not poor and not suffering from serious chronic conditions, this 
increased use may represent spending of low value (even if it is 
positive) relative to its cost. Since that cost must be paid by some 
other taxpayers if not paid by the beneficiary, those taxpayers may 
correctly judge this increase to be inefficient and unfair.
    These two principles are highly consistent if we assume that lower 
income is associated with lower use of drugs, other things equal, and 
that such low use is a matter of social concern. Then the socially 
optimal coverage policy would provide virtually complete financial 
protection for those beneficiaries with incomes just above the Medicaid 
limit. In contrast, for the middle class households that predominate 
among the elderly, the insurance of concern to the government should 
cover expenses more generously as expenses rise, but should provide no 
coverage for small expenses, with the point at which coverage begins to 
take effect related to household income and wealth. A very simple 
version of such a scheme (though one that can be fine tuned if need be) 
would involve insurance that provides full coverage above a deductible, 
with the deductible stated as a percentage of household income. 
Refinements of this approach might make the required deductible a 
smaller percentage of income for lower income households (``progressive 
deductible''), and might provide a corridor of coverage with percentage 
coinsurance before full coverage kicks in.
Spreading the Gains and Adverse Selection
    There are two objections to this simple but powerful model. First, 
because drug expenditures (like all losses for which insurance is 
rational) are unevenly distributed over households, within any time 
period some households (those with low or zero expenses) will get no 
insurance benefits, while a few households with very large expenses 
will get large benefits under catastrophic insurance. This is the way 
insurance is supposed to work, redistributing benefits from lucky 
people who are not ill and have low expenses to the few most 
unfortunate who have the greatest need for help. There is a cynical 
political view that American voters are unable to support an insurance 
plan which is based on catastrophic insurance principles, because 
``most people will not collect anything from the insurance,'' but will 
either have to pay something or, even if the insurance is fully paid by 
taxes, will be miffed at not getting an equal slice of government 
largesse.
    That argument has no support in any view of the political process 
as one that makes rational decisions to maximize the general well being 
of society or of a targeted population like senior citizens. In my 
view, Congress should play an educational and leadership role in 
explaining to citizens (who really and truly do understand it) that it 
is not in the long run desirable that most people ``make money'' from 
insurance; instead, insurance is supposed to help out the most unlucky. 
As suggested earlier, if those ``unlucky'' people who have low drug 
expenses in a given time period need to receive a political payoff, 
providing low deductible or first dollar coverage is an inefficient and 
inequitable (to those with zero expenses) way to do so; just increase 
Social Security benefits to keep with a ``cost of living'' that 
includes drug spending as a component. If some upfront health-related 
benefit must be offered to lower income people, it should be as 
flexible as possible (for example, usable for out of pocket payments or 
supplemental insurance to buy down the deductible), and not be pre-
specified to be a particular percentage coinsurance.
    A somewhat more respectable argument is one that views ``front-
loaded'' benefits as a possible response to adverse selection. Adverse 
selection is such a complicated and poorly understood phenomenon in 
health insurance that it can be used to justify almost anything. The 
notion here is that, if people can estimate in advance whether they 
will have high or low drug expenses in a given year, and if there is a 
positive uniform premium for voluntary catastrophic coverage, such 
coverage will not appeal to those with low expected expenses. They will 
not enter the risk pool, thus raising the average benefit per person in 
the pool. Of course, whether lower risks are in or out has no impact 
whatsoever on the actual expenses by or benefits to the higher risks, 
but the cosmetic effect of having a lower average benefit cost is 
thought to be desirable. More substantively, it is felt that if the 
lower risks are not ``contributing,'' that somehow means that the 
subsidy to the higher risks will need to be greater.
    Such a phenomenon is unlikely. But having the lower risks in the 
pool helps out the higher risks only if the amount of premium charged 
to the lower risks is in excess of their average claims, so that they 
cross subsidize the higher risks. But, especially in prescription drug 
insurance with high predictability of expenses in the short run, the 
lower risks will be unwilling to pay much above their expected claims. 
The claims are small and so pose little risk, and the claims are highly 
predictable. I take a medicine for a chronic condition that costs $30 
per month but am otherwise healthy. I will not be willing to pay much 
more than $360 per year for drug insurance; I cannot be induced to 
cross subsidize voluntarily. Unless lower risks are terribly risk 
averse, there is no financial benefit from keeping them in the pool.
How to Pay for Drugs
    The general principle of insurance reimbursement is simple. The 
price or loss should be determined in competitive markets, and then 
insurance should indemnify insureds against some portion of that loss. 
The insurance should pay an indemnity whose value depends only on what 
the person's illness is and the competitive expense for treating that 
illness. The price paid should be the market price, and should ideally 
be unaffected by and independent of the presence or absence of 
insurance.
    The principle of leaving price setting to the competitive market 
might work for drugs sold in competitive markets, such as generic 
drugs, although even here FTC oversight will be important. However, for 
drugs protected by patents, the situation is more complex. Patents are 
a government-granted monopoly for a limited period of time in order to 
provide incentives for research on and development of new products. The 
dilemma for citizens and for government agencies is this: once products 
are ``invented'' and fixed costs have been incurred, it is desirable to 
get final selling prices down. But such a strategy offers low priced 
existing products only at the cost of less development of new products. 
Thus the part of government that wants to contain medical costs is at 
war with the part that wants to foster medical progress. It is certain 
that, if research and development is undertaken by rational profit 
maximizing firms, lower prospective prices and profits will mean fewer 
new products. The key question here obviously is that of the value of 
products foregone relative to the benefits from lower prices, but no 
researcher or policymaker knows the answer to that question. For the 
present, we must plan policy in ignorance.
    In the face of such uncertainty about what public policy might 
affirmatively do, probably the best policy is again to try to replicate 
(as much as possible) markets with patents that are otherwise 
competitive, especially on the buyer or insurance side. Buyers should 
be free to walk away from products whose price is higher than what 
buyers think they are worth, but no set of buyers should be permitted 
to collude or combine to force prices down. This situation would best 
be accomplished if individuals could choose from a large number of 
different health plans, with the plans having different policies as to 
which drugs they pay for, what prices they pay, and what assistive 
services they provide. One would expect plans to impose some copayments 
that signal to insureds when covered drugs are sold at especially high 
prices relative to other alternatives; ``triple tier'' copayment or 
simple proportional coinsurance will accomplish this goal. I believe 
there is also merit in trying to approximate an indemnity payment 
conditional on the need for some drug in a given therapeutic class; the 
German health system model of reference pricing, in which a fixed 
amount adequate to buy one product in a class is paid but patients are 
free to buy more expensive products with their own money. More 
elaborate versions in which some fraction of the incremental cost is 
covered are also possible.
    When there is a choice of plans, these plans must be allowed to 
differ in both coverage policies and premiums paid by the insured for 
choice to be meaningful; it does not help if there are multiple 
contractors administering exactly the same coverage at the same 
beneficiary premium. ``Competition'' between different plans cannot be 
guaranteed to lead to the lowest possible price, but it probably will 
lead to the best price, the price that best reflects the tradeoffs 
beneficiaries are willing to make between different types of cost 
containment, that squeezes out any insurer profit, and that best deals 
with government granted patent monopolies.
Final Comments
    Although the case for catastrophic insurance coverage for seniors 
that extends to prescription drugs is overwhelming, the addition of 
that coverage makes Medicare's long run future even more difficult to 
plan. The reason is that rising medical care and health insurance 
expenses are almost always driven by the addition of beneficial but 
costly new technology, and because pharmaceuticals have been the 
leading source of that new technology. Because we live (and will live) 
in a world of limited resources, some technologies should not be made 
available to all who would benefit from them. However, we have no 
institutional structure for making such cost-benefit tradeoffs, 
especially not for government-funded coverage like Medicare. The model 
of a panel of wise and dispassionate scientists determining coverage 
for all, tried in some other countries, has some serious problems; to 
let Congress decide on (and be lobbied about) coverage is even worse. 
My own suggestion would be to make a social decision about what level 
of contribution for Medicare is financially sustainable; make that 
amount of funding available to beneficiaries, and let them use it for a 
variety of loosely limited competing plans. See how this works, and 
only add to the budget if serious problems of access to highly 
beneficial products emerge. Such a strategy may be the best one for a 
constrained and uncertain future.
    Three essentially political questions remain: (1) How low a 
deductible at any given income level represents the appropriate 
combination of financial protection for seniors, appropriate incentives 
to use (but not overuse) drugs, and tax burdens on present and future 
taxpayers? (2) What tradeoffs should we make between inexpensive drugs 
today and better drugs for the future? And (3), most importantly, what 
rate of increase in spending for higher quality but more costly 
products do we think is appropriate for the growing numbers of elderly 
in our country?

                                 

    Mr. MCCRERY. On that sobering note, we will go to Dr. 
Reinhardt.

STATEMENT OF UWE E. REINHARDT, PH.D., PROFESSOR, ECONOMICS AND 
PUBLIC AFFAIRS, DEPARTMENT OF ECONOMICS AND THE WOODROW WILSON 
     SCHOOL OF PUBLIC AND INTERNATIONAL AFFAIRS, PRINCETON 
               UNIVERSITY, PRINCETON, NEW JERSEY

    Dr. REINHARDT. Thank you, Mr. Chairman, and Members of this 
Committee for inviting me to share my views on Medicare reform. 
I will concentrate mainly on Medicare reform and not on the 
prescription drug coverage. I am working on a paper on it. I 
haven't totally through. Once I have, I will be happy to share 
on that.
    Now, my testimony grew out of a primer I had written for 
journalists who always kept asking the same questions and to be 
efficient, I just wrote this up and said call me back if it is 
not clear.
    The questions I was asked: What are the deficiencies of the 
traditional program and who is responsible for those 
deficiencies?
    The second question: What form should the competition 
between traditional Medicare and private insurance plans take?
    The third one was what are actually the goals of Medicare 
reform and are these achievable?
    Finally, what are some of the technical and political 
obstacles?
    Now, with respect to the shortcomings, the interesting 
thing is Medicare is a highly popular program. Survey after 
survey shows that if you array public and private insurance 
products, Medicare usually is among the top or the winner. So, 
you are trying to reform a program that is highly popular among 
not only the old, but also the young. It has shortcomings, and 
we have heard these. It has a strange insurance structure. It 
has no stop-loss protection, no catastrophic protection, 
doesn't cover prescription drugs.
    I am asked who is responsible for it? The culture and 
language is bureaucracy. The word ``bureaucracy'' in America is 
a little bit like the word ``French'' is these days. It is 
always not good.
    I analyzed it, and I would defy anyone to prove me 
different. All of the shortcomings of the traditional Medicare 
program are the Congress' responsibility. Think of Medicare as 
an insurance company. The management is the Health Care 
Financing Administration (HCFA) and now CMS. You are the board 
of directors. Then look down what good governance would 
require, and you would find the fault lies in the board of 
directors.
    If Medicare doesn't have prescription drugs, that is 
Congress' fault. If there has never been successful competitive 
bidding, that is Congress' fault.
    I noticed Mr. Walker said that Medicare overpays for 
prescription drugs for oncologists, but straight shooter that 
he is, he points out on page 20, that it is in the statute. 
There is nothing CMS can really do about it. So, that is the 
first thing. There is no reason why this body, the board of 
directors, could not fix the deficiencies that are in Medicare, 
and there are many proposals around on the shelf to do this. 
This is not rocket science.
    The next question that gets asked is: What should be the 
nature of the competition? I think the reasons why some people 
feel that the proposals now before the Congress are actually 
out to destroy the existing Medicare is the idea to put $400 
billion of taxpayer money and give that only to the private 
health plans as a come-on and not to put a drug benefit also in 
the traditional Medicare.
    That would, of course, be a policy quite consciously 
designed to destroy the old Medicare. Maybe that should be 
done, but it should be openly discussed as such. I think 
camouflaging that with pretty language does seem to me to be 
not proper in a democracy.
    The next question comes: What are actually the objectives 
of this reform? Here I have the most difficult problems with 
journalists. I, myself, I have heard again many times this 
morning that we need to reform Medicare. What are we really 
talking about?
    I list on page 7 of my testimony several goals, but let me 
pick on just two. If the idea is that Medicare reform will 
lower total health spending per elderly from all sources, I 
would almost assure you that will not be achieved. I have a 
chart on page 8 where I say, ``Where could those savings come 
from?''
    Would you believe that private health plans can get lower 
fees than the traditional Medicare? I don't think so.
    Would you believe that you can reduce volume more than the 
traditional Medicare? Well, we have the managed care backlash. 
We have just been through it, and the Supreme Court now 
completely killed HMOs by having this ``any willing provider'' 
provision.
    So, the idea that you think you can reduce volume with 
private health plans in Dade County, Miami, and not trigger a 
backlash among the elderly, I doubt it. I think you will find 
there isn't that much volume, unless Congress really gets 
control, unless you get into it.
    When it comes to SG&A, savings and administration, Medicare 
now spends less than 2 percent of the total expenditure on 
administration. I will put to you the proposition there is no 
insurance company in America that could run an insurance 
program this complex and spend only 2 percent on 
administration. In addition, they would have to market 
individually to the elderly, which Medicare does not, and they 
would have to give profits to shareholders, which Medicare does 
not.
    So, I believe there is no source of saving in SG&A. I think 
in chart A, I can ask my colleague here to audit it, I don't 
think I have left anything out. This is, again, not rocket 
science. I put it all out there, and anyone who would argue 
that you can save total spending would have to tell me where in 
this map would you do it.
    Now if, on the other hand, the idea is to let total 
spending go where it may, but to limit just the taxpayers' 
exposure, that of course you could do. The idea there would be 
to lighten the burden on the working population who pays 
payroll taxes and shift it to the elderly themselves. I think 
that could be debated, but I would think, in a democracy, that 
should be put honestly on the table for all the young and the 
elderly to see, so that one could have a forthright, democratic 
debate on this--democrat ``small''--rather than hiding that 
under some other goal.
    There are some obstacles that I see. The CMS--or HCFA 
formerly--has never succeeded to experiment with competitive 
bidding, yet competitive bidding is a core of this reform. So, 
ask yourself how would the health plans ever play along? They 
like administered prices because they can manipulate them. I 
don't think they would like competitive bids.
    We don't have a good risk-adjustment mechanism. The Dutch 
don't, we don't, the Germans don't, and yet having a good risk 
adjuster is the sine qua non of a competitive insurance 
structure. We heard about the Winberg variations this morning.
    Finally, I do ask Medicare can't ever really compete fairly 
with private plans because, say, Humana can pull out of Iowa if 
they don't like it, but Medicare has to stay as the insurer of 
last resort. So, it will be very difficult ever to have a 
really level playing field in this field.
    Those are my remarks. Thank you.
    [The prepared statement of Dr. Reinhardt follows:]

  Statement of Uwe Reinhardt, Ph.D., Professor, Economics and Public 
 Affairs, Department of Economics, and Woodrow Wilson School of Public 
 and International Affairs, Princeton University, Princeton, New Jersey

    My name is Uwe E. Reinhardt. I am Professor of Economics and Public 
Affairs at Princeton University's Department of Economics and the 
Woodrow Wilson School of Public and International Affairs. At this 
hearing, I represent only my own views as a health economist and health 
policy analyst, and not those of any other person or institution.
    I would like to thank you, Mr. Chairman and your colleagues on this 
Committee for the opportunity to share with you my observations on 
proposals to extend coverage for prescription drugs to Medicare 
beneficiaries as part of a reform of the entire Medicare program.
    My statement before you, submitted for the hearing record, draws on 
a longer Primer for Journalists on Medicare Reform Proposals, which I 
have submitted to your Committee as well. It can be accessed at website 
http://www.wws.Princeton. EDU/~chw/memberf.html (Click on ``Uwe 
Reinhardt'' and then on ``Medicare Reform'').
    The Primer was written in response to several inquiries by 
journalists on the Medicare reform proposal released by President Bush 
in early March. In the Primer, I have sought to comment on four 
questions frequently posed by journalists:

      A. What are the deficiencies of the traditional Medicare 
program, and who is responsible for them?
      B. What form should the competition between traditional Medicare 
and private insurance plans take?
      C. What are the goals posited for the proposed Medicare reform 
proposals, and are these goals achievable with the proposed reform?
      D. What might be the technical and political obstacles to such a 
reform?

    In what follows, I shall respond to each of these questions. I 
assume throughout that the reform in question is the one sketched out 
in general terms by President Bush on March 3rd, 2003, although that 
proposal is so sketchy that one could easily, and quite inadvertently, 
do it injustice. But similar proposals had been proposed earlier by 
Senators John Breaux and Bill Frist, and by the Bipartisan Commission 
of the Future of Medicare in the mid 1990s. The general idea of these 
proposals is to have Medicare delegate the tasks of managing the cost 
of health care benefits and their quality to private health plans that 
would bid competitively for the Medicare business. All such plans, 
however, would allow Medicare beneficiaries to stay with the 
traditional Medicare program, in its current form.
    The purpose of my testimony--and of my Primer for Journalists on 
Medicare Reform--is not been to advocate a particular reform plan or to 
oppose one. The intent has merely to raise a series of questions that 
have either not been raised before or have never been satisfactorily 
answered, if they have cropped up before. The testimony, Mr. Chairman, 
is submitted to your Committee in that spirit.
A. THE POPULARITY AND SHORTCOMINGS OF TRADITIONAL MEDICARE
    The Abiding Popularity of the Program: In their recent paper 
``Medicare Versus Private Insurance: Rhetoric and Reality'' (available 
on the Health Affairs Web Exclusive, October 9, 2002), health services 
researchers Karen Davis, Cathy Schoen, Michelle Doty and Katie Tenney 
report on a national survey of some 3,500 adults, and conducted in mid 
2001, according to which ``Medicare beneficiaries are more satisfied 
with their health care under traditional Medicare than are persons 
under age sixty-five who are covered by private insurance.''
    This finding corroborates an earlier survey in 1998 by the Henry J. 
Kaiser Family Foundation entitled ``National Medicare Policy Options 
Survey'' (available on website http://kff.org), which similarly found 
that the traditional Medicare program earns very high marks among 
public and private health insurance products among Americans, both 
young and old.
    The Program's Shortcomings: The popularity of traditional Medicare 
is all the more remarkable, because that program does have serious 
deficiencies, to wit:

    1. It does not cover prescription drugs or long-term care other 
than that associated with an acute-care episode.
    2. It does not provide adequate catastrophic stop loss protection.
    3. It calls for considerable cost-sharing by patients at point of 
service--for example, $840 for the first day in a hospital episode, 
$210 per day for hospital stays in excess of 60 days, $420 per day for 
stays exceeding 60 days, and all costs for stays exceeding 150 days.

    Indeed, because of its spotty benefit package, Medicare currently 
pays for only about 52% of the total health spending for Medicare 
beneficiaries (from all sources). Medicaid pays for another 12% and 
private insurers (so-called Medigap coverage provided by former 
employers or purchased directly by beneficiaries) another 12%. The 
beneficiaries themselves pay for 19% of their total spending out of 
pocket at point of service. For low-income beneficiaries, their out-of-
pocket costs for health care tends to be around 30% of their meager 
incomes.
    The abiding popularity of the traditional Medicare program--in 
spite of its deficiencies--probably reflects three factors.
    First, unlike virtually all other private or public insurance 
products in this nation, which tend to be ephemeral, Medicare coverage 
is permanent. It does provide its beneficiaries with the genuine sense 
of security not enjoyed by most other insured Americans, which is a 
decided plus, especially for elderly people.
    Second, Medicare traditionally has offered beneficiaries completely 
free choice of providers and completely free choice of therapy for 
covered services. Usually, private insurance products have a variety of 
restrictions in this regard.
    Finally, most Medicare beneficiaries have plugged the gaps in 
coverage left by traditional Medicare with Medigap policies, or 
Medicaid comes to their rescue.
    Responsibility for the Medicare's Current Shortcomings: It is 
customary among critics of traditional Medicare to blame its 
shortcomings on its ``unwieldy bureaucracy,'' the Department of Health 
and Human Services Centers for Medicare and Medicaid Services (CMS), 
formerly the Health Care Financing Administration (HCFA). Among people 
with distaste for government, that theory has great currency.
    A major point I make to journalists is that this accusation is a 
bum rap. Responsibility for Medicare's shortcomings rests almost wholly 
with the program's Board of Directors--the Congress of the United 
States. For example:

      If the traditional Medicare program does not cover 
prescription drugs, it is so because the collective will of the 
Congress of the United States has willed it so.
      If the traditional Medicare program does not work as a prudent 
purchaser with selective centers of excellence or with other preferred 
providers known to give cost-effective care, it is so because Congress 
has expressly forbidden that kind of contracting and prudent 
purchasing.
      If the traditional Medicare program does not engage in 
``disease management'' or ``managed care'' of any type, it is so 
because Congress has not permitted Medicare to pursue these avenues.
      If the traditional Medicare program has hardly ever had the 
benefit of being able to solicit competitive bids for the products and 
services it purchases on behalf of beneficiaries, it is so because the 
Congress has willed it so.

    Until the early 1990s, private health insurers typically did not 
cover prescription drugs either. Virtually none of them employed any 
utilization or cost controls, and most of them paid providers whatever 
they were billed by the providers of health care, rather than 
negotiating fees. Consequently, throughout most of the 1980s, Medicare 
spending per beneficiary rose much less rapidly than did the (per 
capita) premiums charged by private health insurers. As is well known, 
that differential in favor of Medicare is observed today as well.
    To be explained, then, is why Congress decided to sit on its hands 
during the 1990s, as private insurers began to modernize their approach 
to health insurance and cost containment. It is a question not properly 
posed to CMS. It is a question properly addressed to the Congress 
itself, which failed to expand Medicare's benefit package in step with 
modern clinical developments, and which incessantly micro-managed 
Medicare's bureaucracy, preventing the very innovations whose absence 
are now being deplored, sometimes by Members of Congress themselves.
    To illustrate, how can the Congress justify to the American people 
that it has budgeted for Medicare an administrative overhead allowance 
of less than 2%. No private health insurer could possibly manage so 
large and complex a program at so low an expense ratio? Congress' 
posture on this budget item seems almost designed to prevent Medicare 
from managing its affairs effectively. Why is this so?
    Similarly, how can the Congress justify to the American people that 
the budget for operations research it appropriates for the CMS (about 
$15 million a year) is only about 0.0038% of total spending by the CMS? 
Consider, if you would, the graph on the next page. For decades 
Congress has been apprised by health services researcher John H. 
Wennberg, M.D. and his associates at Dartmouth University that, even 
after adjustment for inter-county differences in the age-gender 
composition of the elderly population, of case-mix severity and of 
practice costs, Medicare spending per statistically equivalent 
beneficiary varies by a factor of three across the nation (see the 
graph below). Remarkably, Congress has never shown any interest in 
funding research that might uncover what difference such spending 
differentials might have on the quality of the beneficiaries' lives. It 
is all the more remarkable as the Congress expresses concern over the 
economic implications of the retiring Baby Boom. After all, if 
physicians in many of the Sunbelt States were to adopt the more 
conservative practice style of, say, the Mayo Clinic in Rochester, 
Minnesota, the retiring Baby Boom really would not be a major economic 
problem for this relatively young nation.
    Finally, how can the Congress justify to the American people that, 
during the 1990s, it has consistently intervened with the bureaucracy 
on behalf of the health insurance industry, preventing experiments with 
competitive bidding for the Medicare business by private health plans? 
To quote in this regard from an analysis of this remarkable record by 
Bryan Dowd, Robert Coulam and Roger Feldman:

      Most Medicare reform proposals would replace the current 
payment system with some for competitive pricing [of insurance 
products]. However, efforts over the past five years to demonstrate 
competitive pricing for M+C plans have been blocked repeatedly by 
Congress, even when the demonstrations were directly responsive to a 
congressional mandate. In the absence of political support, a 
demonstration of competitive pricing may be infeasible, and Congress 
could be forced to take the risky step of implementing broad Medicare 
reforms with very little information about their effects.'' \1\
---------------------------------------------------------------------------
    \1\ Bryan Dowd, Robert Coulam, and Roger Feldman, ``A Tale of Four 
Cities: Medicare Reform and Competitive Pricing,'' Health Affairs, 
September/October, 2002; pp. 9-27. This volume of Health Affairs 
contains several other papers and commentaries on the issue of 
competitive bidding.

[GRAPHIC] [TIFF OMITTED] T9405A.012

    Source: John E. Wennberg et al., Dartmouth Atlas of Health Care 
---------------------------------------------------------------------------
1999, AHA Press, 1999: Chapter One Table, pp. 33-40.

    Viewed in their entirety, Congress' policies on traditional 
Medicare convey the impression that Congress has deliberately stunted 
the evolution of Medicare in step with modern clinical and 
organizational developments. It is fair to inquire why that is so.
B. WHAT FORM SHOULD COMPETITION BETWEEN TRADITIONAL MEDICARE AND 
        PRIVATE HEALTH PLANS TAKE?
    As a general rule, it is always a good idea to subject publicly 
administered programs to competition from private-sector entities 
capable of delivering the same benefits, where that is feasible. For 
that reason, one should welcome any reform that sets up a fair and 
intellectually manageable competition between the traditional Medicare 
program and equivalent private-sector health insurance products, if 
only to offer citizens a wider choice--the ability to exit a 
relationship with the public program.
    The Virtue of Choice: We take it for granted that ``more choice'' 
always is to be preferred to ``less choice'' in the design of social 
programs, even though modern behavioral economists would warn us that 
there can be such a thing as too much choice. It happens when choices 
set before individuals are not accompanied by adequate information on 
these choices. It also happens when the sheer complexity of the choice 
menu overwhelms the individual's capacity to make rational choices.
    If the Administration and the Congress wish to confront Medicare 
beneficiaries--especially the frail elderly--with ever more complex 
choices in health insurance, it is incumbent upon government to 
accompany these choices with clear information about them and to 
structure them so as to make rational choice manageable by ordinary 
human beings. In this regard, one is not at all assured by the recent 
headline that ``Medicare Officials Order End to Instructive Services'' 
(The New York Times, January 25, 2003, p. A12). The article opens with 
the statement:

      ``Running short of money, Medicare officials have ordered 
immediate cuts in a wide range of services that provide information, 
advice and assistance to Medicare beneficiaries.''

    Once again, the temptation here is to blame the ``Medicare 
bureaucracy'' for this budget reallocation. As I have noted above, the 
fault really lies with Congress' insufficient appropriation for 
Medicare's administrative expense.
    Be that as it may, if this is an augury to come for Medicare 
reform, then ``more choice'' may well end up as ``more confusion'' 
among beneficiaries and ``more regret'' and disillusionment ex post. If 
Congress really seeks to reform Medicare along the lines proposed by 
the President, then Congress must show better faith in regards to the 
information infrastructure the reform presupposes.
    The Fairness of Competition: The next question is what form the 
competition among alternative insurance products in Medicare should 
take. Two distinct visions of this competition are now put before the 
American people.
    One arrangement would be to style the choice and competition among 
health insurance products as one between (a) a modernized, government-
run Medicare program that includes prescription drugs, preventive care 
and catastrophic coverage, and that is allowed by Congress to use 
techniques of modern ``managed care'' and (b) equivalent private-sector 
insurance products managed by private health plans. The arrangement 
would attempt to create a level playing field between a government-
administered Medicare and private-sector competitors.
    An alternative arrangement--one deliberately designed to erode the 
popularity of the traditional Medicare program--is to style the choice 
and competition in Medicare as one between (a) the traditional, 
unreformed, government-run Medicare program, whose development has been 
and will continue to be deliberately stunted by the Congress and (b) 
more modern private-sector insurance products offered by private health 
plans. It appears to be the style of competition preferred by the 
President, who would endow the traditional Medicare program with only a 
skimpy drug benefit \2\ and subsidize drug benefits through private 
plans more heavily, and who would otherwise not alter Medicare's 
benefit package.
---------------------------------------------------------------------------
    \2\ Medicare beneficiary choosing to stay in the traditional 
Medicare program would receive free of charge a drug-discount card--
presumably administered by a pharmaceutical benefit management company 
or a private insurance carrier--to benefit from bulk purchasing. They 
would also have catastrophic coverage for drug spending exceeding an 
annual threshold, which is left unspecified. Low income beneficiaries 
would, in addition, receive a $600 annual subsidy toward their drug 
purchases.
---------------------------------------------------------------------------
    No one, probably not even its proponents, would call the second 
style of competition fair. It is the analogue of a parent offering a 
high school graduate, as a graduation gift, a choice between (A) a Ford 
Taurus and (B) a similar Chevrolet, on the condition that the parents 
will pay for a CD player in the Ford Taurus and pick up the annual 
maintenance costs on it, but that they will not cover these items for 
the Chevrolet. It can be doubted that either GM or the kid would call 
this a fair choice.
    What rationale one might offer for styling the competition between 
Medicare and substitute private health plans in this unfair way.
    First, it might be argued that, under our system of political 
governance and campaign financing, it will always be impossible for 
Congress to modernize Medicare in step with changes in modern medicine. 
The argument would be that Congress and successive Administrations have 
managed Medicare as poorly as they have because, by its very nature and 
its method of campaign financing, American government manages 
everything it does poorly. It is a troublesome thought.
    Second, it may be argued that government-run health insurance 
programs are inherently cumbersome, because they must strive to be 
horizontally fair to all parties, while market mechanisms usually are 
not subject to that constraint, unless government imposes on them. To 
illustrate, Medicare must observe scrupulously horizontal equity in its 
dealings with hospitals and physicians. (Horizontal equity means two 
physicians or hospitals would always be treated the same way). There 
are public hearings on proposed changes, notices in the Federal 
Register, comment periods, and such. By contrast, private health plans 
need not be so fair. They can treat different physicians differently, 
if they can cut different deals with them, and they can change rules or 
contracts with providers and patients overnight, without much notice, 
and subject only to the tort system and contract law. Therein lies 
greater flexibility.
    A third argument for the proposed, unfair competition might be 
that, by their respective natures, private health insurance plans will 
always be more efficient than government-run insurance plans in 
anything they do. In principle, that hypothesis is amenable to 
empirical verification, after one has defined carefully what is meant 
by ``efficient.'' If there is a body of empirical research that 
convincingly supports this hypothesis (which there might be) I am not 
aware of it. In any event, if private health plans really are more 
efficient than is traditional Medicare, why then would they need the 
boost of a special public subsidy available only to them (and not the 
traditional Medicare) to be competitive with traditional Medicare?
C. WHAT IS THE GOAL OF MEDICARE REFORM?
    It has never been clear to me just what the goal posited for 
Medicare reform might be, because usually the authors of such proposals 
remain silent on the subject. I can think of several distinct goals, to 
wit:

       Reduction in total health spending per Medicare 
beneficiary, from all sources, however it may be split between 
taxpayers and Medicare beneficiaries.
       Reduction only in the taxpayer's exposure to Medicare 
spending, even if it increased total health spending per Medicare 
beneficiary.
       Obtaining better value for the health care dollar, 
whatever the source, and whatever Medicare reform does to total health 
spending per Medicare beneficiary, from whatever source.
       Rescuing the private health insurance from a slow death 
march caused by the ever-finer risk segmentation that occurs under mass 
customization of private health insurance.

    In what follows I shall briefly explore each goal in turn, 
referring readers to my Primer for a lengthier exploration.
    Goal 1--Reduction in Total Health Spending: If the goal of the 
proposed Medicare reform were to reduce total health spending per 
Medicare beneficiary--from all sources, including the beneficiaries 
themselves--then I doubt that this goal will be achieved with the 
proposed reform. I come to this conclusion by ruminating on the sketch 
on the next page.
    Given the awesome power traditional Medicare has to set 
administered prices for Medicare, it can be doubted that private health 
plans can buy benefits for the beneficiaries at lower prices, or even 
at the prices Medicare now pays. It may be argued, of course, that 
these prices are too low, and that private health plans would set more 
appropriate, higher prices. Whatever the merits of that idea, however, 
it would drive up total health spending per Medicare beneficiary, not 
lower it, other things being equal.

[GRAPHIC] [TIFF OMITTED] T9405A.013


    It may be argued, next, that private health plans would lower total 
health spending per beneficiary by ``managing'' health care utilization 
(volume) more efficiently than does traditional Medicare, perhaps 
through disease management. At the abstract level, this argument has a 
certain appeal, especially in view of the previously cited Wennberg 
variations. But there are practical obstacles to this strategy.
    First, if attempts by private health plans to ``manage'' the 
utilization of health care by employees triggered a ``managed care'' 
backlash in the younger generations, one can only imagine what backlash 
that attempt would trigger among Medicare beneficiaries and their 
physicians, if these much maligned (though theoretically defensible) 
managed-care techniques were applied to the elderly population.
    Second, there is scant empirical evidence that the private health 
plans so far have performed much disease management. One would have 
thought that these plans should have been able to earn a fortune by 
managing health care properly in counties where their premiums were 
based on 95% of a very high Average Actuarial Per Capita Cost (AAPCC)--
e.g., Dade County Miami, Baton Rouge, Louisiana, and so on. Yet when 
Congress capped the premiums paid the plans for the high cost countries 
under the Balance Budget Acts of 1997 (BBA 97) at an annual growth of 
2%, the plans professed not to be able to manage with those premiums. 
Evidently, there are narrow limits to the plans ability to reduce 
utilization even in high-utilization areas.
    Third, the concept of Enhanced Medicare proposed by the President 
envisages health insurance products otherwise known as Preferred 
Provider organizations (PPOs), which resemble nothing so much as open-
ended, unmanaged indemnity products. Such open-ended plans are unlikely 
to control volume significantly better (if at all) than traditional 
Medicare does now.
    Finally, it is doubtful that the total fraction of the premium that 
plans need for marketing, administration and profits (SG&A plus 
profits) under a privatized Medicare program will be lower than the sum 
of the administrative cost of traditional Medicare (less than 2% of 
expenditures, see graph below) plus those of Medigap policies.

[GRAPHIC] [TIFF OMITTED] T9405A.014

    Source: CMS, http://cms.hhs.gov/charts/default.asp, CMS Facts & 
Figures, II. CM Program Operations, June 2002 Edition, Slide II.6.

    In sum, if, relative to traditional Medicare, private health plans 
would be unlikely to achieve (1) lower prices, (2) significantly lower 
volume or (3) lower SG&A costs, whence then would come any cost savings 
from privatizing Medicare?
    Goal 2--Limiting the Taxpayer's Exposure to Medicare: If the goal 
of Medicare reform were merely to limit the taxpayer's contribution to 
the health-care cost of Medicare beneficiaries (even if that drove up 
total health spending on them from all sources) that goal could be 
achieved with such a reform, at least theoretically.
    In effect, the reform would be designed to convert the Medicare 
program from its traditional structure of a defined benefit program 
(which saddles taxpayers with the risk of health care cost inflation) 
to a defined contribution program (which would shift the risk of future 
health-care cost inflation substantially onto the shoulders of Medicare 
beneficiaries). It would, in effect, represent a reallocation of an 
essentially uncontrollable fiscal burden from the young to the old.
    In view of the burden of the retiring Baby Boom and the inexorable 
decline in the number of workers per elderly in the decades ahead, such 
a strategy certainly deserves careful consideration. If that be the 
goal of Medicare reform, however, one would hope that those positing it 
would do so straightforwardly, for open debate in our democracy.
    Goal 3--Obtaining Better Value for the Dollar: It may be argued 
that private health plans can obtain better value for the Medicare 
dollar (regardless what total health spending on Medicare beneficiaries 
may be), because these plans know how to manage health care better than 
does traditional Medicare.
    Although that proposition has appeal, there is the caveat that any 
such attempt at ``managed care'' might trigger the backlash alluded to 
above. Indeed, the President's proposed Enhanced Medicare is explicitly 
designed to spare Medicare beneficiaries these ``managed care'' 
techniques.
    Furthermore, there is no reason why traditional Medicare could not 
be allowed to purchase health care more prudently than it is now 
allowed to do and to engage in modern disease management. Government-
run or -controlled health insurance programs abroad--e.g. in Germany--
certainly are now experimenting with this approach. If Congress wished 
to attain better value for the health care dollar under traditional 
Medicare, it could certainly achieve that goal.
    If, on the other hand, Congress as a matter of fiat steadfastly 
refuses ever to allow traditional Medicare to manage itself and the 
care it procures more efficiently, then almost by definition and by 
deliberate design private health plans will have a comparative 
advantage in this regard. In that case, however, it would seem 
reasonable to ask Congress for an explicit justification of such a 
policy.
    Goal 4--Rescuing the Private Insurance Industry from Self-Afflicted 
Demise: In my Primer for journalists, I explore at greater length the 
effect that the ever-finer risk segmentation within the private health 
insurance sector will have on the fraction of the health care dollar 
that the private sector will control in the future.
    Although the sector currently covers two thirds of the American 
population, it accounts for only about one third of total national 
health spending. It is so, because fiscal responsibility for the more 
costly citizens--the blind and disabled and the elderly--has been left 
to the public sector.
    If the private insurance industry continues to segment risks as it 
has in recent years--through ever more sophisticated ``mass 
customization'' of its policies--then more and more chronically ill 
Americans will be flushed out of its book of business and onto the 
mercy of government. Thus, a decade hence the private sector might 
control only 25% of total health spending.
    One could think of the proposed Medicare reform as a strategy 
designed mainly to rescue the private insurance industry from this 
self-inflicted wound. It would be a purely political decision, of 
course, that one would be hard put to justify on economic grounds.
D. OBSTACLES TO MEDICARE REFORM
    Among the potential obstacles facing the proposed reform of the 
Medicare program, and listed in my Primer for journalists, are the 
following:

    1. Competitive Bidding: Competitively bid premiums are the central 
core of most proposals to privatize Medicare, the President's included. 
Competitively bid premiums are thought to be the main engine for 
quality and cost control. Yet, as noted earlier, previous attempts by 
Medicare to experiment with competitive bidding by private health plans 
has met with stiff resistance from the health plans. They have 
invariably been killed, courtesy of the good offices of the Congress. 
What assurance do the proponents of Medicare reform have that the plans 
would embrace the competitive bidding envisaged by the proposal?
    2. Risk Adjustments: Any system of competitive enrollment of 
diverse people by price-competitive private health insurance plans 
requires that the premiums paid the plans be adjusted for the actuarial 
risk of the enrollees choosing the plans. Unfortunately, no one in the 
world has yet developed a satisfactory risk-adjustment instrument for 
this purpose. The risk adjuster currently used by Medicare for its 
Medicare+Choice program, although fairly sophisticated by international 
standards, has been vehemently criticized by the health plans. 
Concretely, then, what ideas for risk adjustment do the advocates of 
the proposed reforms have?
    3. Wennberg Variations: There is the question how a reformed 
Medicare would cope with the previously cited Wennberg variations in 
Medicare spending. These variations have hitherto been politically 
acceptable, because they are known only to the cognoscenti. The 
proposed reform might flush them out to greater visibility and trigger 
political controversy.
    4. Insurer of Last Resort: Finally, there is the question how any 
competition between traditional Medicare and private health plans can 
ever be on a fully level playing field, if the private health plans are 
permitted to withdraw from certain regions of the country in which they 
cannot thrive, while traditional Medicare must stay as insurer of last 
resort. That facet of the proposed reform required further thought than 
it has hitherto been given.

                                 

    Mr. MCCRERY. Thank you, Dr. Reinhardt, and thank all of you 
for your testimony. I am going to turn, first, to the Chairman 
of the Subcommittee on Health, Mrs. Johnson.
    Mrs. JOHNSON OF CONNECTICUT. Thank you all for your 
thoughts and your very thoughtful testimony.
    Dr. Reinhardt, under program shortcomings, you mentioned 
prescription drugs, no stop loss and cost-sharing issues, but 
you don't mention almost total lack of preventive, coverage of 
preventive benefits under Medicare, and more importantly, 
Medicare has no capability to provide management of chronic 
illness. Structurally, it doesn't have that capability, and yet 
about 32 percent of the seniors that have 5 or more chronic 
illnesses are using 78 percent of the resources.
    So, when you say what could plans offer us, the private 
sector is far more advanced than is the public sector in 
managing care, not managing care in the old HMO model; managing 
care in the integrated disease protocols models.
    When you look at the number of people retiring and the 
length of time they are living, and the number of multiple 
diseases they are living with, do you think that there is no 
opportunity to save money in Medicare by better managing 
chronic disease?
    Dr. REINHARDT. Oh, no, I do believe--that is on page 10, my 
goal 3. I said it could be that we assume we get better value 
for the dollar, in particular, disease management, which is 
also I mentioned in the----
    Mrs. JOHNSON OF CONNECTICUT. It is very much of an aside, 
and, to me, if 32 percent are using 78 percent of your 
resources, and that type of patient is going to grow, this is 
not an aside.
    If we want to bend long-term spending in Medicare, we can 
do exactly what has happened in other sectors of our economy. 
Through more integrated teamwork, through better use of 
technology, we have reduced costs and improved quality, and 
that is really what disease management does. It improves the 
quality of care for the individual patient, but it reduces the 
overall cost by reducing hospitalizations, emergency room 
visits, and in many instances even physician visits.
    If this were aggressively pursued in the near term, with 
CMS identifying these patients and giving them incentives to 
join such plans, the issue really isn't would this save money, 
in my mind; the issue is how do you do it? How do you let both 
private-sector plans that have demonstrated that they are doing 
this well do this for our seniors, and how do you provide 
access to coordination of care, management of diabetes, 
management of heart disease, these kinds of things in rural 
areas where there is no plan?
    There almost invariably is some small hospital or medical 
practice that, with the resources, particularly the technology, 
could do this. This is springing up from the medical community, 
and it is better quality and lower cost.
    So, your analysis is interesting, but it is too focused on 
where we are now and the way we have always viewed care. If we 
are going to view care more holistically and more proactively, 
we will get higher-quality care, and we will be able to, in the 
long run, keep people out of dialysis. That will save us money.
    Dr. REINHARDT. Yes, Congresswoman Johnson, I agree there is 
some experiment or some initial experiments with disease 
management, but I think it would not be accurate to say that 
disease management is now widely practiced in the private 
sector. They, too, are only just beginning, and usually the 
mechanism they use is to contract/subcontract with specialized 
niche companies who do that.
    There is no reason the traditional Medicare couldn't do 
that, too. It could deal with Centers of Excellence, it could 
do selective contracting. It could do almost all of it that a 
health plan can do. The real issue is it needs the authority 
from the Congress to do it.
    I think you might want to invite people like Marilyn Moon, 
who have thought much about this, who would tell you, you don't 
necessarily have to join a private health plan to get disease 
management.
    Mrs. JOHNSON OF CONNECTICUT. My time is about to expire, 
and I want to see if anyone else has a comment. I agree with 
that, but I don't think you want to exclude those systems that 
have more advanced capability than we do. I think you need to 
do both.
    Dr. REINHARDT. Not at all. In fact, I say I welcome always 
competition. Every public program, where feasible, should have 
competition from the private sector, whether it is Federal 
Express and the U.S. Post Office or health plans and Medicare. 
I totally agree with you on that.
    Mrs. JOHNSON OF CONNECTICUT. Dr. Pauly and Dr. Stuart. Do 
you have any comment?
    Dr. STUART. I am sorry?
    Mrs. JOHNSON OF CONNECTICUT. Do either of you have any 
comment on this aspect of cost control and Medicare?
    Dr. STUART. I was going to say that I have trouble hearing, 
and so if I ask you to repeat your question. I also might note 
that Medicare does not cover hearing aids.
    [Laughter.]
    Dr. STUART. Let me make a point about disease management. 
Disease management, actually, as it is practiced by these niche 
companies, typically plays a heavy role in terms of 
prescription drug therapy. So, it would be very, very difficult 
for Medicare, as it is currently constructed, to encourage 
disease management, because one of the central elements of 
disease management in the private sector is simply not 
available to Medicare. So, I think that simply making 
prescription drugs available would actually make it feasible to 
develop disease management approaches.
    Dr. PAULY. Well, I am both more and less optimistic than 
Professor Reinhardt. I think if we judge from the competition 
between managed care and fee-for-service in the private sector, 
although we don't have any definitive estimates, my entry in 
the office pool is that managed care saved about 15 percent. 
Now, that was a one-time saving, but it was what resulted in 
very low rates of growth for private sector spending from about 
1994 to 2000. You might be able to see that same sort of saving 
within Medicare, but it would require what managed care 
required in the private sector, which is limitation, greater 
limitations on patients and providers, and that would fly in 
the face of what people love about today's Medicare. I will say 
though I am, in 4 years, contemplating being eligible for 
Medicare, and one of the things I worry about is a point that 
Chairman Thomas made this morning. I worry about the relevant 
comparator, you need to have the relevant comparator. My 
judgment is today's Medicare is not sustainable. I am not sure 
whether it is sustainable for the next 4 years, but is 
certainly not for as long as I hope to be around and a burden 
on my children. So, I think the affection that people feel for 
a very generous program, of whose cost they pay less than 10 
percent, is not something that we can continue to hold out for 
future generations of elderly people, so we need to think about 
how to change that.
    The good news is that some private sector plans may be able 
to save money, although they will probably require some 
restrictions that Medicare beneficiaries are not used to. The 
bad news is that potentially the savings that private sector 
plans can achieve, which in part result from obtaining lower 
prices and discounts to providers, Medicare may have already 
achieved. So, at least the part about better negotiation with 
providers, at least to judge from the complaints of hospitals 
and physicians these days, Medicare may have already made those 
cuts, so there may not be as much of a gain.
    In keeping with the tradition of economists as professional 
wet blankets, I guess what I see as the main advantage of 
competition in Medicare is that when the inevitable 
restrictions come, I would rather have a choice of how to have 
those restrictions imposed on me, rather than have them decided 
unilaterally and in a monopolistic way.
    Mrs. JOHNSON OF CONNECTICUT. Thank you.
    Dr. PAULY. It is a kind of name your poison phenomenon.
    Mrs. JOHNSON OF CONNECTICUT. Thank you. My time has well 
expired. Sorry.
    Mr. MCCRERY. Mr. Stark.
    Mr. STARK. Thank you, Mr. Chairman. I am confused about 
what it is we are trying to hear today. I wanted to ask Dr. 
Reinhardt some questions, but I would ask Dr. Pauly, if he 
would be so good--he mentions the research about lowering the 
copayment produces a 65-percent increase, and if you could at 
some point after the hearing or subsequently just give me a 
reference to that, I would be interested in looking into that 
further.
    I wanted to get to why we are talking about Medicare 
reform, as in quotation marks, and that is, what are we trying 
to do? I am going to ask Dr. Reinhardt to give me what my 
choices are, and also to comment on this often stated theory 
that competition and free enterprise are what is missing in 
controlling the delivery of health care, medical care, to 
particularly seniors. For one thing, I am confused when people 
talk about choice in prescriptions. I don't know if anybody in 
this room, including some of the physicians, could tell me what 
half the prescription drugs that are advertised in People 
Magazine do for you or to you. I am sure that none of us are 
apt to go off and buy some just for the hell of it if we don't 
know what is going to drop off or quit working if we take this 
stuff. I don't know any of us that know the cost of any of 
these tests. I have often stated that if I offered witnesses a 
half-price proctological examination at George Washington this 
afternoon, would you run up and take it? No, you wouldn't. Only 
if your doctor told you to you might.
    So, what is this market based on? I went to a school where 
they taught marketing, and they had some economists there and 
they talked about having to have a knowledge of the market and 
how do consumers decide if they don't know what the hell they 
are buying?
    So, I wonder, Dr. Reinhardt, if you could elaborate for us 
a little bit about what--accepting your challenge that we have 
to fix it, what in broad terms are our options in fixing it, 
which is to provide a proper amount of medical care to all 
Americans, and what factors would help us most, free market, 
complete competitive bidding? Go ahead.
    Dr. REINHARDT. Well, starting with the latter, the 
competitive bidding, California Public Employees Retirement 
System, which is the biggest purchaser of health care in 
California, your State, last year had 25-percent premium 
increase. These were highly competitive plans, and the question 
of course you have to ask yourself in Congress, is that the 
kind of cost control that we can afford; is that sustainable, 
or how do you make this sustainable? I think your only option 
is to roll that responsibility over on the elderly, which maybe 
should be done, but I think that should be openly discussed to 
what extent that is the goal of Medicare reform.
    I think whenever you hear people say the people should have 
more ``skin in the game,'' as the language is, fiscal skin in 
the game, what is actually really being talked about though--
and again, maybe that should be done--you want to ration health 
care by price and ability to pay, and it is the lower half of 
the income distribution who should carry the burden because 
think of someone in the top first or second percentile of the 
income distribution, someone making more than $200,000. What 
does it actually mean for them? I'm in that position. Cost 
sharing doesn't mean a thing to me. Whatever it is, I'll pay 
it. So, it has zero effect on people like me, but if you were a 
gas station attendant, cost sharing has a major effect. So, we 
are saying like food is rationed and like housing and clothes, 
we would like to ration health care. That way the burden would 
mainly be borne by the lower half of the income distribution.
    There is no reason why a nation might not choose that as 
long as you are honest about it, that is what markets--or cost 
sharing, that is what it really achieves. I am not--I think I 
am more inclined, as Mark says, to have some choice as always, 
because most airlines are the same, lousy food, lousy planes, 
but it does give you some pleasure to be able to tell one 
airline to go to hell. I have often done it, just the last 
minute I have rebooked, and I think that is sort of what Mark--
pick your own poison, so to speak. There is some virtue in 
that, and that is why some competition is obviously very good. 
When the President talks about enhancement Medicare, which is 
essentially PPOs, which is essentially warmed-over fee-for-
service, unmanaged. I cannot imagine where the savings would 
come from, other than this ability, Mark says, to have some 
choice is always a good thing.
    Again, I want to emphasize I am not at all against it; I am 
for it. I would worry about having a popular program such as 
Medicare--which is not more expensive, as Marilyn Moon's 
research shows--abolished simply because some people don't like 
the esthetics of it.
    Mr. STARK. Thank you.
    Mrs. JOHNSON OF CONNECTICUT. [Presiding.] Mr. McDermott.
    Mr. MCDERMOTT. Dr. Reinhardt, knowing the injunction about 
not casting pearls before swine--there are very few of us 
left--but I would like to give you a Blue Book question. If a 
country can for 120 years provide a guaranteed set of benefits, 
including prescription drugs, as Germany has done, what is it 
that is wrong with Medicare that--or what do we need to change 
in Medicare to make the same thing possible for the elderly in 
this country?
    Dr. REINHARDT. Well, you would need to modernize the 
benefit package. It is sometimes overlooked that until 1990, 
Medicare was the more innovative program that kept step. 
Medicare covered renal dialysis when it was technically 
feasible. Medicare introduced diagnosis related groups. 
Medicare introduced the fee schedule. It was only after 1990, 
when the private plans introduced prescription drugs, that 
Medicare fell behind. Those plans also didn't cover preventive 
care until about 1992. So, when you talk about modernizing, 
mainly it is that you have to have a modern benefit package.
    What makes Germany cheap are two things. One, simplicity. 
It is a very simple program. It has very low administration. 
There was a McKinsey Global Institute study that showed in 1990 
Americans actually got $390 less health care--doctor visits, 
pills, and so forth. So, we were clinically more efficient, 
they said, because we spent less. Ninety percent of that was 
spent on administration.
    I am on the board of the Duke University health system. We 
consolidated our billing, and I was told we have 900 people in 
the billing department. I got kind of angry, and I said, well, 
is that Medicare--Medicare compliance? The answer, no. For the 
most part it is because we have 60 different plans, each with 
their own rules, they don't pay. Medicare pays within 20 days, 
it is electronic. Private is still all paper.
    So, Germans save a lot of money on administration by having 
standard billing forms, standard fee schedules, and those kind 
of things; where here there are no fee schedules. We have a 
market without prices. I defy anyone to give me the website in 
Washington, DC where I could find out what different physicians 
cost. Each fee schedule has 9,000 items in it. How would you 
technically even do this? You need somebody to negotiate these 
things for you. I think that is, of course, Medicare's 
advantage. It is a simple program. Prices could be negotiated, 
too. You set them, but they could be negotiated, the way 
Germans do it, and make the program a lot simpler.
    There is no question, Germany's population today is as old 
as ours will be only in the year 2020. Yet Germany's spending 
per capita is about 57 percent of ours. There is no discernable 
difference in health status.
    Mr. MCDERMOTT. What is their mechanism by which they 
control the pharmaceutical industry? The pharmaceutical 
industry is as big in Germany as it is in this country, I 
think, on some relative scale. How did they deal with the cost 
of pharmaceuticals?
    Dr. REINHARDT. They use what I think both Professor Pauly 
and I would call a market approach called reference pricing, 
where they classify groups into therapeutically equivalent 
classes of drugs, reimburse fully--not the cheapest, but sort 
of the third way up drug--and then tell the patient if you want 
a more expensive drug, you have to pay the whole difference 
between that benchmark, the reference price, and that brand-
name price, out of pocket. That has really worked, 
substantially, in Germany.
    In addition, though, they also put a budget on top of drug 
spending. Reference pricing is very much hated by the 
pharmaceutical industry, because in Germany the prices of brand 
names tended to collapse to the reference price. The 
pharmaceutical industry then fears that there won't be enough 
of a margin for innovation. That has been the argument.
    Mr. MCDERMOTT. Do you agree to that, that if we put 
reference pricing in our system, suddenly there would be not 
enough money in the system for innovation?
    Dr. REINHARDT. I think what you need to do to build those 
groups is to have absolutely first-rate science to make sure 
that really better drugs actually don't get penalized, that it 
is only the me-too drugs that you push down. That is where 
there might be some controversy.
    I think as a general rule, if you take money away from the 
pharmaceutical industry, every item in their income will 
probably go down. They are spending 13 percent of revenue goes 
for research and development (R&D). If you took a buck away, 
there might be maybe 13 cents of R&D might disappear. Marketing 
would disappear, too, and other things as well. When you take a 
dollar away from a drug company, I don't think Mark and I would 
say you lose a dollar R&D. That is not true.
    Mr. MCDERMOTT. Thank you.
    Mrs. JOHNSON OF CONNECTICUT. Mr. Becerra.
    Mr. BECERRA. Thank you, Madam Chair. Thank you to the three 
of you for your testimony. If I can, I would like to just 
follow up on a couple of things that Dr. Reinhardt mentioned 
earlier.
    First, Dr. Reinhardt, you mentioned that Congress as the 
board of directors, as you said, could, if it chose, address 
some of the concerns that we have with the current system of 
Medicare. Let me ask you this--and I would pose this to the 
three of you. Should we, if we end up with a privatized system 
of health care for our seniors, whether it is for prescription 
drugs or general for Medicare, should we require attributes all 
providers, private insurers, in the case of a private plan, be 
required to offer a plan in all geographic parts of the 
country? Which is something that, I think, Dr. Reinhardt, you 
mentioned that Medicare doesn't have a choice in Iowa or 
anywhere else, it has to offer to that senior. Should we impose 
that as a requirement on any private insurer if we go toward a 
privatized system of Medicare?
    Dr. PAULY. No, I don't think so. I think some insurers, the 
Blue Cross insurers, although it is changing, wouldn't be 
capable of offering something country-wide. I think it would do 
a lot of violence to the current structure of insurance 
markets.
    Mr. BECERRA. Who would then cover----
    Dr. PAULY. Let me say what I think, what----
    Mr. BECERRA. Dr. Pauly, if I could ask you, who would then 
cover, if it wouldn't be Blue Cross or any other private 
insurer----
    Dr. PAULY. Well, it doesn't have to be every insurer in 
every location. If--and this is the next point I wanted to 
make--if insurers are not willing to enter Iowa or wherever, or 
Ohio, where I came from, or Pennsylvania, where I am now, that 
is a sign that the current payment rates are inadequate. The 
solution to that is not to force them to enter areas where they 
are sure to lose money. Even if you are able to be effective, 
they will de-market their services and provide very poor 
service. The solution is to adjust the payment rates so that it 
is equally profitable, at least as much as you can approximate 
it, for insurers to enter in all parts of the country. That 
will surely mean, as we heard some discussion this morning, 
paying more in some areas than others because in rural areas 
you can't have the same kind of economies of scale as you can 
have in urban areas, but on the other hand, you are not paying 
big-city prices, either.
    Mr. BECERRA. That doesn't seem to reduce the cost overall 
of Medicare if we are having to increase the costs that we pay 
in certain parts of the country to encourage the private sector 
to go into those areas that Medicare currently services.
    Dr. PAULY. No, I think this would be an attempt to be more 
equitable and even-handed in providing access.
    Mr. BECERRA. It would increase costs?
    Dr. PAULY. I am not sure it would increase costs. That 
depends----
    Mr. BECERRA. Well, if it doesn't increase costs, why can't 
we keep the level of reimbursement as it is, what Medicare 
currently is receiving, or what we are providing it to offer 
these services?
    Dr. PAULY. You would lower it in some places and raise it 
in others if you thought access was currently unequal.
    Mr. BECERRA. I see. I see. I don't know, Dr. Stuart, if you 
wish to add anything to that?
    Dr. STUART. No.
    Mr. BECERRA. A question with regard to what Dr. Reinhardt 
said in terms of the total health care spending and how you 
come up with that calculation, the fees times the volume plus 
your costs. Do any of the other panelists disagree with what 
Dr. Reinhardt has identified as the variables, the factors that 
we would take into consideration, that formula for determining 
overall costs? Dr. Stuart or Dr. Pauly? Any disagreement? I 
don't want you to go into it, just to--I wonder if you agree or 
disagree.
    Dr. STUART. Well, I think it is an accounting framework, 
and the elements of the accounts are there. So, one might 
disagree in terms of where savings might be obtained in one of 
the elements as opposed to another element. I think, certainly, 
the model itself is complete.
    Mr. BECERRA. Can anyone identify for me a private insurer 
which today administrative costs that are lower than what 
Medicare spends? There, Medicare doesn't market, so it doesn't 
have marketing expenses. It also doesn't seek to secure a 
profit. So, if we could factor in marketing and profit into 
that cost of administration, can anyone name for me a private 
insurer that right now offers a health plan and benefits for a 
lower administrative cost as I have defined it than does 
Medicare?
    Dr. PAULY. Well, the literature says--actually, it doesn't 
identify private insurers by name, but the traditional 
estimates in the literature on group insurance are that large 
group insurance, say the General Motors-type firm, would have 
administrative costs of around 5 percent.
    Mr. BECERRA. That is still higher than Medicare.
    Dr. PAULY. It is still higher than Medicare, but the 
difference, as you mentioned is that Medicare raises its money 
via compulsory taxes and private insurers don't have that 
luxury or that privilege. To my understanding, the pure cost of 
claims processing is not terribly different between Medicare 
and private insurers. The primary difference, the thing that 
explains why Medicare is at 3 percent and private insurance on 
average is at around 13 percent, are those selling costs. You 
have to talk people into private insurance. You don't have to 
talk them into Medicare because it is 10 percent subsidized--
only paying 10 percent of the price, and also billing costs. 
When people buy private insurance, somebody has to remind them 
to pay their bill every year.
    So, there are a lot of good things to say about Medicare, 
but I actually think the administrative cost saving is somewhat 
of a red herring. If you compared kind of equivalent costs for 
doing equivalent things, the people up on Security Boulevard 
are wonderful people, but I don't think they are any better or 
worse than the private sector.
    Mr. BECERRA. I think that is a very good point in terms of 
the marketing, that as a mandated program you don't have 
marketing costs, you don't have to try to go out there and 
solicit business. Dr. Stuart, did you want----
    Dr. STUART. I think there are a couple of other elements 
here on, actually, both sides of the argument. One of the 
arguments behind the difference in measuring administrative 
costs in a public program and a private program is that 
although what you count as an administrative cost in a private 
program might show up in terms of higher prices or in terms of 
inefficiencies in the public program. So, you have to be 
careful when you are just looking at that stratum that goes to 
administration on the balance sheet, or on the income 
statement.
    The other thing that I might note is that the 
administrative costs under Medicare are managed. Those costs 
are determined by budgets. You determine how much Medicare 
spends on administration by how much you are willing to give 
CMS to carry out its mandate.
    Mr. BECERRA. My time has expired. I would just like to make 
sure that--I didn't hear anybody mention a particular private 
plan in place that offers its services for a lower 
administrative cost than does Medicare. I think the point is 
well taken, though, in terms of marketing. There may be some 
value in having a mandated system which doesn't require 
marketing nor the profit element in terms of costs that 
ultimately seniors have to absorb in order to be provided with 
a health care benefit.
    I thank you very much, and thank you, Madam Chairman.
    Mrs. JOHNSON OF CONNECTICUT. Thank you. Before I recognize 
the next speaker, I would like to point out that Medicare's 
administrative costs do not include Treasury's costs of 
collecting the Medicare tax nor the inspector general's cost of 
their portion of overseeing Medicare with the fraud and abuse 
function, which the private sector covers.
    In addition, I don't know, and I will ask the experts, has 
anyone ever done any study of the combined administrative costs 
by the government and the administrative costs that the payor 
pays on the provider? For instance, Medicare imposes much 
heavier costs on home care providers than private sector 
providers impose on home care providers. That is one of the 
reasons why I am trying to eliminate the Outcomes Assessment 
Information System form for private-care patients. So, has 
there been any combined look at administrative costs of both 
the government and those on its providers that it has imposed, 
versus the private sector's administrative costs and the 
administrative costs that they impose on providers?
    Dr. REINHARDT. I think that is a good point and worth a 
study. There are compliance costs with Medicare, particularly 
when you have a corporate integrity agreement, which is one of 
those letters that oblige you to be audited and so on. What 
struck me in the Duke example--and I have asked in the other 
company on whose board I am, too--the unbelievable back-and-
forth to get a claim paid, that goes back several times.
    Mrs. JOHNSON OF CONNECTICUT. In Medicare, you mean?
    Dr. REINHARDT. In the private plan, where your payment days 
outstanding may be 90 or 100 days. So, if you take Duke, for 
example, we have a float of $250 million a year that has to be 
financed. I asked, well, why aren't we getting paid? They told 
me, well, Medicare is not the problem; we get paid in 20 days.
    Mrs. JOHNSON OF CONNECTICUT. Dr. Reinhardt, if I may 
interrupt you, if you have ever been to a doctor trying to get 
paid for comprehensive physical versus a detailed physical with 
very different payment rates, you can see exactly this long 
paper trail. I have one hospital that has an intensivist 
overseeing their intensive care unit. It is saving Medicare 
money. We have a code for this and never, ever have they been 
able to get paid under the Code. They just provide more and 
more documentation.
    So, frankly, I am loaded with examples of that kind of 
problem going on over months or years. At one point, Medicare 
stopped paying for all partial hospitalizations in my State and 
it took us 9 months to straighten it out. So, I would have to 
have a study show me that there were more serious payment 
controversies in the private sector than those in the public 
sector.
    Dr. REINHARDT. Well, as I said, it really would be worth 
studying.
    Mrs. JOHNSON OF CONNECTICUT. It would be worth it.
    Dr. REINHARDT. I would include an administrative cost on 
the private side; also, of course, the claims processing. I 
don't do it. I just refuse. My wife does it. She tells me that 
her claims processing is worse than doing the income tax. She 
does the income tax, too. So, we have a good apple-to-apple. 
She says dealing with the insurance is a lot worse.
    Mrs. JOHNSON OF CONNECTICUT. On the other hand, having just 
broken my ankle about a year ago and being a Medicare 
recipient, I can tell you the number of mailings that I 
received for a simple broken ankle was scandalous, from 
Medicare, scandalous. So, I do think we should try to find 
that, and any of you--and let me let the others comment and 
then we will let the other two Members question before we have 
to go. So, briefly.
    Dr. PAULY. Just two comments. First, there are estimates of 
the administrative cost at hospitals for third-party payment 
and they run around 20 percent. So, they are certainly not 
trivial. I haven't ever seen any Medicare versus private 
sector. Of course, if it is hopeless to try to get money out of 
Medicare, there is no point in a doctor wasting administrative 
costs.
    Mrs. JOHNSON OF CONNECTICUT. We do have only 13 minutes 
left, and I have two questioners----
    Dr. PAULY. Some physicians feel that way. The other point I 
wanted to make, though, I think an important, often neglected 
to mention, administrative cost to the Medicare system is, 
well, the slogan is one-size-fits-all. I don't much like that 
sloganeering, but people buy Medigap coverage to tailor 
Medicare to their own desires. So, really, the administrative 
costs of Medigap plans ought to be attributed to Medicare. If 
you did that, you would end up with a lot more than 3 percent.
    Mrs. JOHNSON OF CONNECTICUT. A very valid point. I am 
sorry, Dr. Stuart, since we only have 15----
    Dr. STUART. Let me just take 1 minute to suggest an area in 
which administrative costs are going to be a major concern for 
Congress as it considers the Medicare drug benefit, and that is 
the administrative costs that are imposed on the private sector 
by private plans developing wildly different formularies. I can 
tell you that this is very costly to medical practices, because 
the physicians can't figure out which patients are covered 
under which plan and which drugs they should get. It is 
particularly costly on pharmacies because the patient comes in 
and the drug is not covered under the formulary----
    Mrs. JOHNSON OF CONNECTICUT. That is a very important 
consideration. We may get back to you on that. Mr. Pomeroy.
    Mr. POMEROY. My time is very brief, but I want to ensure my 
colleague, Ms. Tubbs Jones, also has time. So, I think that I 
will pull back out of the weeds a little bit of how we 
restructure Medicare. I will note consensus across the panel 
that some work is needed here, even though there may be 
substantial difference in terms of how we proceed.
    The thing that I am wondering about is regardless of what 
we have by way of exact delivery of benefit mechanism under the 
name of Medicare, how we pay for it in the next decade if we 
don't do some preparatory work this decade to strengthen the 
financial position of our country to prepare for the 
entitlement hit of baby boomers. It would seem to me 
specifically that paying down the debt this decade would make 
more sense than adding to it significantly, because I believe 
borrowing in the next decade will absolutely be essential to 
cash flow the requirements that we see in the Medicare trust 
fund.
    If we could run across the panel and give us your counsel 
on that one. Would it be better to increase the debt or 
decrease the debt for purposes of preparing to meet the 
entitlement challenge of baby boomers, or is it your position 
that we should simply back off of those entitlement 
commitments. Dr. Reinhardt?
    Dr. REINHARDT. Well, I would have been in favor of not 
increasing the deficit, actually try as much as possible to 
have a surplus and buy back the debt. That is really supply 
side economics. How would that work? You could imagine the 
Medicare trust fund just buying through the Treasury, buying 
back bonds. Those bonds would be owned by pension funds. They 
would have to recycle that money into the private sector. That 
is the clearest way to get 100 percent of that money into 
investment. If you instead give it in tax cuts to individuals, 
like myself, who benefits from these tax cuts, I might buy a 
new Mercedes--in fact, I have--with the money and it might not 
yield productivity.
    So, I believe going the route of having less of a deficit. 
Once the day will come when Europeans may not wish to hold 
dollars or other nations, they may wish to hold euros. That 
seems already to be happening. It could be happening throughout 
the Middle East. You will see interest rates skyrocket in the 
United States.
    So, I think the fiscal policy we are now on, to my mind is 
not the right path.
    Dr. PAULY. Well, I would risk controversy by saying I 
prefer a smaller debt to a larger debt. I don't think that is 
the most important thing that will determine the future 
viability of the Medicare and other entitlement programs. I 
think it is the overall economic health of the economy, so that 
the rate of growth of gross national product (GNP) and the 
level of real GNP is a lot more important than the level of 
debt. Other things equal, lower debt is better than larger 
debt, but if the economy can be made to operate better, that is 
going to be much more important. That is the first thing I 
would do to save Medicare.
    Mr. POMEROY. Significantly higher debt could even 
interfere, perhaps, with some of the economic----
    Dr. PAULY. Well, it is the ratio of debt to GNP that you 
ought to pay attention to, not the absolute level of debt. I 
would rather work on the GNP side than----
    Mr. POMEROY. I accept that, but for the known fiscal hit we 
all know about--lives in being with existing entitlement 
commitments--that it seems to me should also be factored in, 
unless we are straight-up talking about diminishing those 
entitlement commitments.
    Dr. PAULY. Well, I personally think we ought to start 
talking about diminishing those entitlement commitments 
because, given the demographics, I don't see any way to avoid 
that. I guess that is the other solution--this is only my own 
personal solution--have more grandchildren. That would help a 
lot.
    Mr. POMEROY. Thank you. Thank you very much, Dr. Pauly.
    Dr. STUART. Well, I will make it three in terms of reducing 
the debt. I happen to believe that the absolute level of the 
debt is important as well as the relative level of the debt, 
and I am concerned to see the debt rising as fast as it is.
    I do think, however, that when one makes decisions about 
Medicare, it is going to be very difficult, if not impossible, 
to make a decision about the entire program. I really believe 
that is true. So, what that means is that you are going to have 
to deal with incremental changes within that program. So, when 
we, each of us received the invitation to talk today about 
modernization in Medicare with a prescription drug benefit, I 
think the prescription drug benefit should be treated on its 
own merits. What you really need to do is you need to say is 
this something a modern Medicare program should have--and I 
believe you will say yes--and then the question is how best to 
do it.
    Mrs. JOHNSON OF CONNECTICUT. All but 8 seconds of the 
gentleman's time has expired, so if we may move on to Ms. Tubbs 
Jones. We have 5 minutes before the vote.
    Ms. TUBBS JONES. Five minutes?
    Mrs. JOHNSON OF CONNECTICUT. Five minutes. You can take 4 
minutes.
    Ms. TUBBS JONES. I won't take that long, probably. Dr. 
Pauly, you say you are from Ohio. Where?
    Dr. PAULY. Cincinnati.
    Ms. TUBBS JONES. Cincinnati, oh, the other end of the 
State. They say it is like Cleveland and Cincinnati are in two 
different States. All joking aside, one of the biggest problems 
we have had with health care in Ohio is the fact that the 
private insurers have not been required to contract, that they 
could just give notice and say ``I'm gone'' and in 30 days the 
people having health care under the HMOs in Ohio have just run 
away. So, then we end up with people with no health care 
coverage. That is why I have a real dilemma with pushing 
Medicare into the HMOs, based on the experience that my 
Medicaid constituents have had with the HMOs.
    Real short: How do I resolve that problem? If I agree I 
want to go with private insurers, how do I resolve the running 
away from my constituents?
    Dr. PAULY. Well, you have to pay them enough to make it 
worth their while to stay.
    Ms. TUBBS JONES. Except when they enter into the contract, 
they know what I am going to pay them.
    Dr. PAULY. Presumably, they run away when the contract is 
expired, not before.
    Ms. TUBBS JONES. Well, we have had it as terrible as 30 
days. I am not going to argue that. That is my dilemma with the 
private insurers.
    Dr. PAULY. Then I would say write more iron-clad contracts. 
The fundamental aspect of private firms is that they need to be 
able to cover their costs in order to remain in business.
    Ms. TUBBS JONES. Dr. Reinhardt, how do I resolve this issue 
as we reform Medicare?
    Dr. REINHARDT. Well, one is to pay more. Then Congress, of 
course, loses any sense of budgetary control, have even less 
than they have now. Or the alternative is to make sure the old 
Medicare is always there as a fallback position, which would be 
my--my favoring that program is because it is a fallback 
position.
    Ms. TUBBS JONES. Why do we always have to worry about 
deficit spending when it comes to programs such as Medicare and 
Medicaid, and we don't ever worry about deficit spending when 
it comes to things like military spending and the other issues? 
I voted for the Supplemental, and I support the military. I am 
just wondering why that number always comes up. Dr. Pauly?
    Dr. PAULY. Well, I don't worry about deficit spending for 
Medicaid, at least the part of it that pays for children, 
because I view you are making an investment in children and 
that is as good as an investment in national security. I think 
for senior citizens, in a way, it is more difficult because it 
is less easy to make the argument that the spending will yield 
returns.
    Ms. TUBBS JONES. If I was sitting at the table and I had to 
decide whether you got services, and you would live or not 
live, you would want me to let you live, wouldn't you? Or give 
you the treatment that was necessary for you to hang around for 
a little while?
    Dr. PAULY. Well, certainly, but those are presumably not 
the services that we are talking about rationing or not 
rationing.
    Ms. TUBBS JONES. In your prior testimony, you alluded to 
it. I am going to end my time, Madam Chairman. Thank you, 
gentlemen, for giving us this opportunity.
    Mrs. JOHNSON OF CONNECTICUT. Thank you very much for being 
here. I appreciate it very much. I do hope we will get a chance 
to pursue this conversation later on as the bill develops. 
Thank you.
    [Whereupon, at 2:41 p.m., the hearing was adjourned.]
    [Submissions for the record follow:]

 Statement of Cori E. Uccello, and John M. Bertko, American Academy of 
                               Actuaries

    The American Academy of Actuaries appreciates the opportunity to 
provide comments on issues related to expanding coverage of 
prescription drugs in Medicare. The Academy is the non-partisan public 
policy organization for actuaries of all specialties in the United 
States.
    This statement focuses on three areas that Congress needs to 
address as it designs a Medicare prescription drug benefit:

       First, if enrollment in the drug program is voluntary, 
the program must be designed to minimize adverse selection. That is, 
actual program enrollment needs to be nearly universal, broad enough to 
include healthy participants as well as those who would be expected to 
be high utilizers of the program. Otherwise, per-enrollee costs could 
become too high, potentially leading to the need for increased 
beneficiary premium contributions and cost sharing, and discouraging 
the participation of private entities that administer and/or deliver 
the benefit.
       Second, the plan must include components that will help 
minimize per script costs, contain drug utilization, and keep total 
spending to an affordable level. Otherwise, drug spending under the 
program will grow much faster than projected, further endangering the 
solvency of the overall Medicare program.
       Finally, policymakers may want to add risk-sharing 
provisions during the first few years after implementation to private 
sector organizations administering or delivering the benefit. Risk-
sharing provisions are especially important in the early years of the 
program, until pent-up demand levels off and utilization data for 
previously uninsured beneficiaries becomes available.

    These issues are discussed in more detail below, along with options 
for addressing them.

Adverse Selection
    Adverse selection can be a problem in any voluntary health 
insurance program. Because people in poor health are more likely to 
purchase coverage, and to purchase more generous coverage in 
particular, premiums will increase significantly to cover the impact of 
this selection. Indeed, in typical private insurance programs in which 
premiums are paid entirely by participants, the average cost for those 
who enroll will be well above the average of all potential applicants. 
As premiums are set higher to reflect the higher costs of enrollees, 
even fewer applicants are willing to pay them, further increasing 
selection effects and the average per enrollee cost.
    The potential for adverse selection is even greater for a stand-
alone Medicare prescription drug program because seniors can better 
predict their future drug costs than their other health care costs. The 
key to minimizing adverse selection in a Medicare prescription drug 
program is to increase participation rates, which can be accomplished 
through various means, including:

       Premium subsidies. When deciding whether to participate 
in the program, many seniors will evaluate the perceived value of the 
program and compare their expected out-of-pocket drug costs to the 
plan's premiums. Those who expect to have covered drug costs that are 
less than the premium required to participate will be less likely to 
enroll. Premium subsidies reduce the direct cost of participation, 
increasing the number of eligible individuals who will expect their 
likely benefit from the program to exceed the premium cost, and thus 
will increase enrollment.
       ``Default'' enrollment. Making enrollment in the drug 
program the default option (i.e., seniors desiring not to be in the 
program would have to take a step to opt out) would increase 
enrollment.
       Penalty for delay. Mandating that enrollment in the 
drug plan be on a guaranteed-issue basis would ensure that all seniors 
have access to the benefit, regardless of health status. However, these 
enrollment features could encourage seniors to delay enrollment until 
they expected to incur significant prescription drug expenses. Limiting 
guaranteed issue to an initial open enrollment period, or providing 
some other meaningful penalty for late enrollment, would encourage 
individuals with low current drug expenditures to consider their future 
needs and protect themselves by enrolling.
       Risk Adjustment. In the absence of universal coverage, 
some degree of adverse selection is inevitable. Risk adjustment and/or 
other types of reinsurance arrangements can reduce the incentives an 
insurer might have to avoid enrolling high-risk individuals. These 
options are discussed in more detail below.

    The combination of these elements would help to reduce adverse 
selection, thereby increasing the program's long-term stability. In 
addition, because private insurers would hesitate to offer plans if 
they feared they would be selected against, reducing adverse selection 
would also increase the likelihood that insurers or other organizations 
would participate in the program.

Drug Utilization Management
    The CBO estimates that prescription drug spending by the Medicare 
population will total $95 billion this year and will nearly triple to 
$284 billion by 2013. The introduction of a Medicare prescription drug 
program would likely increase drug spending even further due to induced 
or pent-up demand. In other words, because drug coverage would reduce 
the out-of-pocket costs of prescription drugs to consumers, they would 
be able to afford to use more drugs. One-third or more of seniors 
currently lack prescription drug coverage. Prescription drug spending 
by this population is very likely to increase dramatically if they 
obtain comprehensive drug coverage. Utilization could increase even 
among seniors with drug coverage (e.g., through a retiree health plan, 
Medigap, Medicare+Choice plan) if the Medicare prescription drug plan 
is more comprehensive than their current plan.
    The long-term sustainability of a Medicare prescription drug plan 
depends in part on the extent to which the plan can manage drug 
utilization and spending. Many tools are available to help contain 
utilization and costs, including patient cost sharing, limiting the 
range of drugs covered, and drug utilization management mechanisms.

       Patient cost sharing. Patient cost sharing through 
deductibles, copayments, and/or coinsurance will reduce the overall 
cost of the program in two ways. First, it directly reduces the share 
of the costs borne by the insurance program. Second, and equally 
important, cost sharing will also make patients more sensitive to 
prescription drug costs, thereby reducing utilization to that which is 
medically necessary and, ultimately, overall costs.

        Deductibles are amounts that must be paid out-of-pocket before 
drug coverage begins. Aside from lowering the cost of benefits paid, 
low or modest deductibles help hold down administrative costs by 
eliminating claims processing for small amounts. Large deductibles in 
effect result in catastrophic coverage, which provides coverage for 
those most in financial need of assistance at a relatively low cost.
        With coinsurance, the patient is responsible for a percentage 
of the drug cost. Copayments, on the other hand, are a fixed amount per 
prescription and have the advantage of being more predictable to 
patients. However, copayments might not make patients as sensitive to 
the costs of drugs as does coinsurance. Also, whereas coinsurance 
automatically adjusts for increases in drug costs, copayments (and 
deductibles) need to be increased periodically as drug costs rise, or 
overall program costs will increase faster than drug costs.
        By making patients more sensitive to costs, cost sharing will 
decrease prescription drug utilization. Although the goal of cost 
sharing is to reduce unnecessary utilization, it will likely reduce 
necessary utilization to some extent as well. Reducing the cost-sharing 
requirements for lower-income seniors will help minimize the extent to 
which cost sharing discourages needed care. However, some minimal level 
of cost sharing should be present for even the lowest income levels to 
deter unnecessary utilization.

       Formularies. Formularies are lists of a plan's 
preferred medications and are used to encourage the use of less costly 
drugs. There are three types of formularies--open, closed, and 
incentive. Under open formularies, all drugs are available with no 
incentive to choose one over the other, although programs can be 
designed to encourage use of preferred medications (e.g. therapeutic 
interchange programs). In contrast, closed formularies limit the drugs 
available under the plan to those listed in the formulary. Incentive-
based formularies contain cost-sharing differentials for preferred and 
non-preferred brand name drugs, and generic drugs, thereby giving 
patients a financial incentive to request preferred or generic 
medications. Nevertheless a non-preferred drug may be the only drug 
that is fully effective for a particular person, leaving the 
beneficiary paying more unless exceptions are available.

        Merck-Medco, a pharmacy benefit manager (PBM), has estimated 
that the cost savings that derive from formularies can range from 2 
percent to 3 percent for an open formulary with compliance 
interventions to 5 percent to 9 percent for a three-tier incentive-
based formulary. It is important, however, that any formulary be broad 
enough to include drugs in each therapeutic category and class of 
covered outpatient drugs. In addition, the formulary must be 
periodically reviewed and modified to reflect new drugs being 
introduced and updated clinical information.

       Drug Management Mechanisms. Insurers and/or pharmacy 
benefit managers have several mechanisms they can use to help contain 
drug costs:

        Prior authorization requires physicians to receive 
authorization that the drug is appropriate for the medical condition 
and could save from 1 percent to 2 percent of drug spending. Because it 
is expensive to administer, prior authorization is typically reserved 
for expensive drugs that have potential for excessive use or misuse.
        Maximum dispensing limits restrict the quantity of medication 
a patient receives over time or per fill, and could also save about 1 
percent to 2 percent of drug spending. This technique may be 
appropriate for therapies in which the potential for excessive use 
affects either cost or clinical outcomes.
        Step therapies are used to check the medical appropriateness 
of using a newer, more expensive medication (i.e. a second-line drug) 
rather than a traditional medication (i.e. a first-line drug) for the 
same condition. This technique encourages the use of traditional 
therapies if they are more cost-effective than newer therapies and the 
new therapies offer minimal to no additional clinical benefit. Step 
therapies could save from 1 percent to 3 percent of drug spending.
        Online drug utilization review can be performed electronically 
at the point of sale to ensure that the patient is eligible for the 
plan and that the prescription has not been refilled too soon. It can 
also screen for any drug interactions and perform other systematic 
checks. This concurrent review can save up to 4 percent of drug 
spending.

Risk Sharing
    Many of the recent Medicare prescription drug coverage proposals 
suggest not only using private sector organizations to deliver the 
benefits, but also having these organizations share in the financial 
risk. Although private sector organizations have some experience with 
the risks associated with providing prescription drug coverage, either 
through employment-based, Medicare+Choice, or Medigap plans, these 
organizations lack experience with the overall senior market and there 
are increased risks associated with a new Medicare prescription drug 
benefit. In addition to adverse selection risks related to the 
program's overall participation rates, a Medicare prescription drug 
plan is also subject to risks associated with the difficulty in pricing 
the benefit adequately and plan-specific adverse selection. Each of 
these risks is discussed below, along with potential methods of 
addressing these risks.

Pricing Risk
    It will likely be difficult for private sector organizations to 
estimate the per capita costs of a stand-alone prescription drug 
program for several reasons. First, the costs for seniors who are 
currently without drug coverage are uncertain. About one-third of 
current Medicare beneficiaries lack any prescription drug coverage. 
Their future prescription drug consumption will likely increase under a 
Medicare prescription drug benefit, but it is unclear how large that 
increase will be. Understating these costs could result in large losses 
to private sector entities. Overstating these costs could result in 
overpayments by the government.
    Moreover, the lack of comprehensive data on current prescription 
drug usage by seniors makes it difficult to estimate costs under the 
program, even for those seniors who currently have prescription drug 
coverage. For instance, using cost estimates derived from Medigap plans 
could be unreliable. On one hand, these estimates could overstate costs 
due to the likely adverse selection from seniors who choose these 
plans. On the other hand, using spending data for seniors with 
relatively limited Medigap prescription drug coverage could understate 
costs under a more comprehensive prescription drug program. Because of 
the potentially enormous volume of senior drug spending, even a 10 
percent misestimate in a single large State could cause a $100 million 
loss (or unexpected gain).
    Not only is it difficult to accurately estimate initial levels of 
prescription drug spending, it is difficult to estimate the trends in 
spending. Drug spending among the nonelderly with employment-based 
coverage has grown recently, as much as 15 to 20 percent per year, due 
to a combination of higher drug prices, increased utilization, and the 
introduction of new and expensive drugs. On one hand, a Medicare 
prescription drug program that provides near-full coverage may have 
cost increases of that magnitude. On the other hand, drug utilization 
may not increase as quickly among the senior population if they are 
already using many drugs.
    In order to mitigate the pricing risk issue, policymakers may wish 
to consider shared risk arrangements that protect the government from 
over-paying and provide protection for those organizations willing to 
participate. Risk corridors provide a mechanism to limit an 
organization's potential losses and gains to a more acceptable level. 
Reinsurance could also limit an organization's potential losses. In 
addition, using performance standards for administrative tasks in the 
first several years of a new Medicare prescription drug program could 
ease the transition to an insurance risk-based system. Each of these is 
discussed in more detail below.

       Risk corridors are contractual safeguards that can 
limit both the downside risk and upside gain for an insurance 
organization.\1\ In a typical arrangement, a best estimate of the 
claims and administrative cost of a benefit would be made. Gains or 
losses inside a risk corridor around that estimated level would be the 
full responsibility of the private sector organization. Additional 
gains or losses beyond the risk corridor would be shared with or borne 
by the Federal Government. As a result, an at-risk organization such as 
an insurance company would be able to offer coverage, but its risk 
would be limited.
---------------------------------------------------------------------------
    \1\ The Federal Government has large-scale experience with the use 
of risk corridors through its TriCare contracts, which provide health 
benefits to military personnel, their dependents, and military 
retirees. In addition, there are other risk corridors now being used in 
Medicare Private Fee For Service and PPO demonstrations.
---------------------------------------------------------------------------
        The example below illustrates how risk corridors work:


----------------------------------------------------------------------------------------------------------------

----------------------------------------------------------------------------------------------------------------
Best estimate of annual Medicare                                                     $1,000 per year per senior
  prescription drug premium
----------------------------------------------------------------------------------------------------------------
First-year Medicare prescription drug                                                     1 percent
  risk corridor
                                                               (i.e., the corridor is 2 percent wide around the
                                                                                                 best estimate)
----------------------------------------------------------------------------------------------------------------
Dollars at risk per senior in first year                          $10 per year per senior possible gain or loss
----------------------------------------------------------------------------------------------------------------
Federal Government responsibility                                                                              Losses in excess of $1,010
                                                                 Gains if costs are less than $990 per year per
                                                                                                         senior
----------------------------------------------------------------------------------------------------------------


        In this example, if the insurance company enrolled 1 million 
seniors, its maximum loss would be $10 million (1 million seniors times 
$10 maximum loss per senior), with the government covering any losses 
over $10 million. Similarly, if cost estimates proved to be 
conservative, then the Federal Government would recover any gains that 
exceeded $10 million.
        Risk corridors or other risk-sharing arrangements might be 
essential during the first few years of a Medicare prescription drug 
program. During the period in which risk corridors are in place, both 
insurers and the Federal Government would be able to gather the drug 
expenditure data needed to make more accurate cost estimates for future 
years. As a result, this mechanism could be useful as a transition to 
full-risk contracting. (In the past, the Federal Government has had the 
time to conduct pilots or demonstrations on a small scale to gather the 
necessary beneficiary data, before implementing a new program. That 
time may not be available for a new Medicare prescription drug 
program.)
        For example, in the second year, the risk corridor could be 
expanded from 1.0 percent (a corridor 2 percent wide) to 
2.5 percent (a corridor 5 percent wide) to allow for 
greater incentives for the private sector organization. Other 
provisions could include some cost sharing (e.g., 10 percent) outside 
the corridor. In other words, the insurer would be responsible for all 
claims within the first 2.5 percent corridor, then 10 percent within an 
additional 5 percent corridor.

       Aggregate Reinsurance is another option to limit 
insurers' downside risk. Under aggregate reinsurance, the Federal 
Government would pay all or a percentage of claims once a private 
plan's aggregate claims paid exceed a pre-determined threshold. This 
threshold is typically expressed as a percentage of aggregate expected 
claims (for example, a first-year aggregate limit might be 102 percent 
of projected paid claims). Insurers would keep all gains if actual 
claims are lower than expected. Government-provided aggregate 
reinsurance protection is similar to a one-sided risk corridor. In 
other words, the insurer would keep all gains, regardless of the size, 
if actual spending is less than expected, but would bear the losses 
only up to a certain point if spending is greater than expected. 
However, aggregate reinsurance may be easier to administer than risk 
corridors. Other mechanisms, like premium stabilization reserves, 
funded by some level of underwriting gains, could be added to limit the 
possibility of unintended funding windfalls.

       Individual Reinsurance can protect a plan from 
unexpected high claims from individual beneficiaries. Although there is 
much less variation in prescription drug spending among Medicare 
beneficiaries compared to other health spending, plans can still be at 
risk for unusually high claims among individual enrollees. Under 
individual reinsurance, the Federal Government would pay all or a 
percentage of claims once an individual enrollee's claims exceed a pre-
determined threshold (typically expressed as a dollar amount, such as 
$7,500). Individual reinsurance, however, would not provide much 
protection for plans from higher than expected aggregate costs under 
the threshold, which could occur especially in the first few years of 
the program due to induced or pent-up demand.

       Performance standards are another approach that can be 
used to encourage cost containment. These measure plan administrators 
against certain criteria and require them to put a certain amount of 
administrative fees at risk for their performance. For example, a plan 
could have a negotiated goal that a certain percentage of prescription 
drug scripts be generic (e.g., 50 percent) in order to hold down costs. 
If this goal is met, then the Federal Government would provide the 
organization with its full administrative fee payment. Otherwise, a 
portion of the administrative fee payment would be forfeited. Again, 
such incentives might be particularly important during the first few 
years of program operation. After two or more years in this pilot 
state, the contract could be converted into a full-risk contract, in 
which the organization would bear the insurance risk.
        An important issue is the required duration of a risk corridor 
or reinsurance stage. Although prescription drug claims are typically 
paid much more quickly than other medical claims, sometimes within two 
to four weeks of being incurred, it is likely that any bidding process 
would require a pilot stage for the first two years. In year one, no 
data would be available to determine the best estimate of claim costs. 
Bidding for year two would begin almost immediately during the first 
year, so, once again, very little data would be available. By the 
second year of a contract, a full first year of data would be available 
and bidding for the third program year could proceed on an at-risk 
basis, or with a wider corridor.

Plan-Specific Adverse Selection
    Even if adverse selection is minimized in the program as a whole, a 
particular plan could end up with a disproportionate share of seniors 
with high prescription drug expenditures. If payments to the plan do 
not reflect this, then the plan could be at risk for large losses. Risk 
adjustment could be used to adjust the payments to the plans to take 
into account the health status of the beneficiaries who participate in 
the program. Risk adjustment helps to make payments to competing plans 
more equitable and can reduce the incentives for competing plans to 
avoid beneficiaries with higher than average prescription drug needs. 
Risk adjustment may also help stabilize experience among private plans, 
causing less disruption for plan participants.
    Several risk adjustment mechanisms for acute care services have 
been developed using pharmacy data. Pharmacy-based models can also be 
used as risk adjustment mechanisms for prescription drug utilization. 
Although risk adjustment can help account for the differences in 
participant health status across plans, no current risk adjustment 
system is designed to compensate each competitor for the full financial 
effects of adverse selection.

Conclusion
    Proposals to add a prescription drug benefit to Medicare need to 
address issues related to adverse selection, drug utilization 
management, and risk sharing. Adverse selection will be minimized to 
the extent that participation is nearly universal. This can be 
accomplished through high premium subsidies, default enrollment, and 
penalties for delayed enrollment.
    The long-term sustainability of a Medicare prescription drug 
program also depends on the extent to which the program manages drug 
utilization and spending. Patient cost sharing, formularies, and other 
drug management mechanisms can each help contain costs.
    Finally, policymakers may want to provide provisions to minimize 
the financial risk of private sector organizations administering or 
delivering the benefit in the first few years of the program. Risk 
corridors, reinsurance, and performance standards could be used in the 
initial years of a prescription drug program while organizations 
collect important data. Risk adjustment could provide additional 
protection to private organizations, thereby increasing their 
willingness to participate.

                                 

   Statement of David G. Schulke, Executive Vice President, American 
                       Health Quality Association

    The American Health Quality Association represents independent 
private organizations--known as Quality Improvement Organizations 
(QIOs)--that work under contracts with the Centers for Medicare and 
Medicaid Services (CMS) to improve the quality of care for Medicare 
beneficiaries in all 50 States and every U.S. territory. Congress 
created the QIOs to monitor and improve the quality of care delivered 
to Medicare beneficiaries and supports the national work of the QIOs 
with approximately $333 million annually from the Medicare Trust Fund, 
or about $8 per beneficiary per year.
    Past policy efforts to develop a Medicare prescription drug benefit 
for the 21st century have focused almost exclusively on financing a 
benefit. Very little attention was given to including initiatives in 
the drug benefit to ensure a benefit is safe and continuously monitored 
to maximize the quality of outpatient pharmacotherapy.
    It is absolutely critical to create an integrated quality 
improvement program. Otherwise, beneficiaries are likely to be ill-
served by a carved-out drug benefit that operates separately from the 
Medicare hospital and outpatient benefits and data systems.

Building a Safe Drug Benefit.

    A Medicare outpatient prescription drug benefit presents an 
opportunity to improve the quality of life for our nation's seniors, 
but also brings the real risk of increased morbidity and mortality 
associated with an increase in the use of medications. It is reasonable 
to predict that with an outpatient prescription drug benefit, more 
seniors will receive more drugs. Expanding access to and availability 
of drugs, without a complementary investment in quality improvement, 
will exacerbate the unacceptable cost and incidence of hospital and 
long-term care admissions associated with medication use. A recent 
meta-analysis of 11 different studies reviewing drug use in the elderly 
population found that ``[t]he reported prevalence of elderly patients 
using at least one inappropriately prescribed drug ranged from a high 
of 40% for a population of nursing home patients to 21.3% for 
community-dwelling patients over age 65.'' [i]
---------------------------------------------------------------------------
    \[i]\ Lui GG, Christensen, DB, ``The Continuing Challenge of 
Inappropriate Prescribing in the Elderly: An Update of the Evidence.'' 
J Am Pharm Assoc, 42(6), p847-857, 2002.
---------------------------------------------------------------------------
    Pharmacoeconomists at The University of Arizona have tracked the 
costs associated with drug therapy since the early 
1990s.[ii],[iii] In the spring of 2001 these researchers 
published the following statement: ``Overall, the cost of drug-related 
morbidity and mortality [in the ambulatory care environment] in the 
United States exceeded $177.4 billion in 2000. Hospital admissions 
accounted for nearly 70% ($121.5 billion) of total costs, followed by 
long-term-care admissions, which accounted for 18% ($32.8 billion).'' 
[iv]
---------------------------------------------------------------------------
    \[ii]\ Johnson JA, Bootman JL, ``Drug-related morbidity and 
mortality. A cost-of-illness model.'' Arch Intern Med (United States), 
155(18), p1949-56, 1995.
    \[iii]\ Harrison DL, Bootman JL, Cox ER. ``Cost-effectiveness of 
consultant pharmacists in managing drug-related morbidity and mortality 
at nursing facilities.'' Am J Health Syst Pharm, 55(15), p1588-94, 
1998.
    \[iv]\ Ernst FR, Grizzle AJ, ``Drug-related morbidity and 
mortality: updating the cost-of-illness model.'' J Am Pharm Assoc, 
41(2), p191-199, 2001.

---------------------------------------------------------------------------
Integrating Medical and Pharmacy Data Systems through Medicare QIOs.

    Historically, attempts to address the morbidity and mortality 
associated with medication use have been stymied by the inability of 
practitioners in various disciplines to access certain medical or 
pharmacy records that would otherwise provide a comprehensive picture 
of a patient's true medication use history. As this Committee discusses 
building a Medicare prescription drug benefit for the 21st century, it 
is essential that the new statutes and regulations include language 
that provide the QIOs with access to pharmacy claims data. Regardless 
of how a drug benefit is administered, the Secretary of HHS must have 
unrestricted access to pharmacy claims data to use in directing the 
activities of the QIOs. QIOs were created by Congress with the 
necessary confidentiality protections and staff expertise to permit 
them to combine medical and pharmacy data to guide health care systems 
improvement.
    Most congressional proposals forwarded to date rely on the pharmacy 
benefit administrators to process pharmacy claims data and take certain 
quality improvement steps at the point of service when the pharmacy 
claims data suggests medication misadventures. The good work of the 
pharmacy benefit administrators is limited by the information present 
in the pharmacy claim. Without integration of the data present in the 
medical record and pharmacy record, systematic failures leading to 
inappropriate prescribing and dispensing will continue to happen 
everyday.

Integration of Data Systems through QIOs Is Critical--A Study of 
        Outpatient Beta-Blocker Use in Heart Attack Victims.

    QIOs use data to track progress and improve provider performance, 
reducing errors by focusing on treatment processes, mostly 
pharmacotherapy. Since 1996, QIOs have worked on local projects to 
improve clinical indicators in care for diseases and conditions that 
broadly afflict seniors. Among the diseases targeted for quality 
improvement by the QIOs, treating heart attack victims with beta-
blockers offers an example of how the QIOs could further their current 
inpatient efforts with appropriate access to data gathered with an 
outpatient prescription drug benefit.
    Medical practitioners have known for several decades that the 
secondary prevention benefits of beta-blocker therapy after heart 
attack include reduced hospital readmissions, reduced incidence of 
further heart attacks, and decreased overall mortality.[v] 
The evidence is so convincing that the American College of Cardiology 
and the American Heart Association guidelines for the management of 
heart attack recommend routine beta-blocker therapy for all patients 
without a contraindication.[vi] Despite the evidence and 
expert recommendations, the use of beta blockers after heart attacks 
remains considerably suboptimal, with 20-30% of appropriate patients 
lacking this essential therapy.[vii] The reason is unlikely 
to be cost. Beta-blocker therapy in the outpatient setting is one of 
the most affordable medications available to patients. A 90-day supply 
of this life-saving medication usually costs less than $10.00.
---------------------------------------------------------------------------
    \[v]\ Soumerai, SB, McLaughlin TJ, et al. ``Adverse outcomes of 
underuse of beta-blockers in elderly survivors of acute myocardial 
infarction.'' JAMA, 227, p115-121, 1997.
    \[vi]\ Ryan TJ, et al. ``ACC/AHA guidelines for the management of 
patient with acute myocardial infarction. A report of the ACC/AHA Task 
Force on Practice Guidelines (Committee on Management of AMI).'' J Am 
Coll Cardiol, 28, p328-348, 1996.
    \[vii]\ Krumholz HM, et al. ``National use and effectiveness of 
beta-blockers for the treatment of elderly patients after AMI: National 
Cooperative Cardiovascular Project.'' JAMA, 280, p623-629, 1998.
---------------------------------------------------------------------------
    QIOs work to ensure that patients discharged from the hospital 
following a heart attack leave the hospital with a prescription for a 
beta-blocker. In the November 2002 issue of the Journal of the American 
College of Cardiology (JACC), researchers report that many patients 
never fill prescriptions for their discharge medication, and many of 
those that do discontinue the use of beta-blockers shortly after 
filling the prescription. The study's authors conclude: ``Patients not 
discharged on beta-blockers are unlikely to be started on them as 
outpatients. For patients who are discharged on beta-blockers after 
AMI, there is a significant decline in use after discharge. Quality 
improvement efforts need to be focused on improving discharge planning 
and to continue these efforts after discharge.'' [viii] 
During the QIO's Sixth Scope of Work (1999-2002), QIOs were responsible 
for improving the national rate of beta-blocker order at discharge by 
7%.[ix]
---------------------------------------------------------------------------
    \[viii]\ Butler J, et al. ``Outpatient adherence to beta-blocker 
therapy after AMI.'' J Am Coll Cardiol, 40(9), 1589-1595, 2002.
    \[ix]\ Jencks SJ, et al. ``Change in the Quality of Care Delivered 
to Medicare Beneficiaries 1998-1999 to 2000-2001.'' JAMA, 289, p305-
312, 2003.
---------------------------------------------------------------------------
    In his study published in JACC, Butler and colleagues found that 
the first step to preventing heart attack recurrence is to make sure a 
prescription is written and ordered at the time of the patient's 
discharge from a heart attack hospitalization. If this is done, the 
study shows there is a 10 TIMES greater likelihood of getting that 
patient started on inexpensive, effective beta blocker drugs that 20-
30% of Medicare heart attack patients still do not receive, almost 40 
years after the first marketing of propranolol, the first beta blocker.
    The authors of the study utilized data for the dually enrolled 
population of patients (those receiving Medicare and Medicaid benefits 
simultaneously), as this is the only population of seniors for which 
there is comprehensive drug therapy claims data. This same kind of 
monitoring should be available for all beneficiaries. It is critical 
for Medicare to have the drug claims/utilization data so QIOs can 
identify heart attack patients who don't fill a prescription for beta 
blockers post discharge, or who stop filling prescriptions (almost one 
quarter do after 6 months, according to the study)--and give their 
physicians assistance in getting the prescription started or changed 
(the latter might be needed if the patient didn't like the particular 
beta blocker initially prescribed and has consciously stopped taking it 
due to unacceptable or intolerable side effects). QIOs are ideally 
suited to identify patients at highest risk for hospital readmission or 
death due to poor beta-blocker adherence (i.e., patients taking beta-
blockers post heart attack). We believe the QIOs unique ability to 
integrate medical information with pharmacy claims/utilization data 
complement pharmacy adherence programs that may be currently managed by 
benefit administrators.

QIO Confidentiality Requirements.

    The confidentiality of information collected or developed by a 
Medicare QIO is assured by Section 1160 of the Social Security Act. It 
was the intent of Congress in drafting this provision to provide 
safeguards for information identifying a specific patient, practitioner 
or reviewer. These safeguards foster an environment that is conducive 
to quality improvement efforts.

Recommendations.

    The American Health Quality Association has drafted the following 
legislative specifications we ask the Committee to include in this 
year's Medicare outpatient prescription drug benefit bill.

Legislative Specifications for the 108th Congress.

    1) Give the QIOs responsibility for the outpatient drug benefit 
analogous to the responsibility they have for all other Title 18 
benefits:

      Add new `Sec ____. Review Authority--. Section 1154(a)(1) is 
amended by adding ` and section ____ after `1876'.

    2) Instruct the QIOs to make assistance available to providers, 
practitioners and benefit administrators to improve the quality of care 
under the new drug benefit.

    Prescription Drug Therapy Quality Improvement.--Section 1154(a) is 
amended by adding a new paragraph 17:

      ``(17) With respect to items and services provided under Title 
XVIII Part ____ the organization shall execute its responsibilities 
under subsection (a)(1)(A) and (B) by making available to providers, 
practitioners and benefit administrators assistance in establishing 
quality improvement projects focused on prescription drug or drug-
related therapies. For the purposes of this part and title XVIII, the 
functions described in this paragraph shall be treated as a review 
function.''

    3) Include legislative language instructing prescription drug 
benefit administrators to provide patient specific pharmacy claims and 
drug utilization data to the Secretary of HHS. Suggested wording:

      ``Requirements for Prescription Drug Plan Sponsors, Contracts, 
Establishment of Standards.--Any agreement between the Secretary and a 
benefit administrator for this purpose shall provide the Secretary with 
all patient specific pharmacy claims and drug utilization data.''

    4) Include legislative language providing appropriate availability 
of prescription drug claims data to the QIOs for quality improvement 
purposes. Suggested wording:

      ``Data Availability.--The Secretary shall provide the 
utilization and quality control peer review organizations with the 
patient specific pharmacy claims and drug utilization data to permit 
the organizations to perform the functions described in 1154(a)(17).''

                                 

                                   Long Term Care Pharmacy Alliance
                                               Washington, DC 20037
                                                      April 8, 2003
The Honorable William M. Thomas
Chairman
Committee on Ways and Means
U.S. House of Representatives
1102 Longworth H.O.B.
Washington, DC 20515

Dear Chairman Thomas:

    On behalf of the Long Term Care Pharmacy Alliance, I am writing to 
submit this statement for the record of your Committee's April 9, 2003 
hearing on ``Expanding Coverage of Prescription Drugs in Medicare.''
    We appreciate your leadership in considering issues related to the 
creation of a new Medicare prescription drug benefit, and we would like 
to take this opportunity to highlight the special pharmacy needs of the 
nation's frail elderly residing in nursing facilities. We want to work 
constructively with you to ensure the continued provision of quality 
services to these particularly vulnerable seniors.
    While most Medicare beneficiaries are able to walk into pharmacies 
to pick up their prescriptions or to receive vials of pills through the 
mail, a sizable percentage of beneficiaries cannot do so and need 
special services that retail and mail order pharmacies do not provide. 
Nursing home residents have specific diseases and multiple co-
morbidities that require specialized pharmacy care. Without such 
treatment, we cannot expect positive therapeutic outcomes for these 
patients. Failure to take into consideration the special pharmacy needs 
of the frail and institutionalized elderly will lead to a marked 
increase in medication errors and other adverse events.
    Pharmacy benefit managers and insurance companies are not equipped 
to administer a Medicare drug benefit to this vulnerable population, 
because they lack the necessary experience, infrastructure and 
expertise. By contrast, members of the Long Term Care Pharmacy Alliance 
are the nation's major operators of pharmacies that serve the frail and 
institutionalized elderly, and they specialize in serving the needs of 
patients in long-term care settings.
    TCPA members' patients are elderly, frail, chronically ill, and 
can no longer care for themselves. They require a level of pharmacy 
care that goes well beyond what the typical retail or mail order 
pharmacy provides to its customers. To meet these needs, long-term 
pharmacies provide specialized packaging, 24-hour delivery, intravenous 
and infusion therapy services, geriatric-specific formularies, clinical 
consultation and other services that are indispensable in the long-term 
care environment.
    Without ensuring that nursing-home residents and other patients 
with special needs can receive these specialized pharmacy services, a 
Medicare prescription drug benefit could actually endanger the health 
of beneficiaries residing in nursing facilities. We look forward to 
working with you on a specific proposal to ensure appropriate coverage 
of pharmaceutical services for Medicare beneficiaries who reside in 
nursing homes.
    If you have any questions or would like additional information, 
please feel free to contact me at (202) 457-6000. Thank you for your 
consideration of our views.

            Very sincerely yours,
                                                      John F. Jonas
cc: The Honorable Charles B. Rangel
     The Honorable Nancy L. Johnson
     The Honorable Fortney H. Stark

                                 

Statement of the National Association of Chain Drug Stores, Alexandria, 
                                Virginia

    Mr. Chairman and Members of the Subcommittee. The National 
Association of Chain Drug Stores (NACDS) is pleased to submit this 
statement for the hearing on Designing a Medicare Prescription Drug 
Benefit for the 21st Century.
    NACDS represents over 200 pharmacy companies that operate nearly 
35,000 community-based retail pharmacies. NACDS members employ nearly 
100,000 pharmacists and provide about 70 percent of all outpatient 
prescriptions. The majority of our prescriptions are paid for by third 
party insurance companies and pharmacy benefit managers--over 85 
percent--so we have a significant amount of experience in operating in 
the current pharmacy benefit marketplace. Our industry and the patients 
that we serve will be significantly affected by the structure and 
operation of any new Medicare pharmacy benefit. For that reason, we 
need to be engaged and involved in the policy discussions regarding a 
Medicare pharmacy benefit. We believe that we can provide a unique 
perspective on what we feel will work best for Medicare program, 
seniors, and the taxpayers.

Principles for a 21st Century Medicare Pharmacy Benefit

    It is often said that no one would design a contemporary Medicare 
program without a prescription drug benefit. We agree. Prescription 
medications are the most widely used and cost-effective health care 
interventions used by patients today. Modern prescription drugs have 
extended and improved the lives of millions of Americans and saved 
millions of dollars through shortened length of illnesses, increased 
productivity, and reductions in hospitalization and medical procedures. 
Community pharmacy is proud of its role in assuring the safe and 
effective use of these therapies.
    That is why we believe that any new program to expand prescription 
drug coverage to seniors should be a pharmacy benefit, not just a 
prescription drug benefit. Too often, we think of a prescription drug 
benefit as only providing a ``drug product'' to seniors. We believe 
that this is a serious mistake. Seniors take so many more prescription 
medications than younger individuals. For that reason, seniors need 
ready access to community-pharmacy-based education, counseling, and 
medication therapy management, in addition to the drug product, so they 
can take their medications appropriately to achieve the intended 
medical outcomes.
    NACDS, along with seven other national pharmacy and related 
organizations, developed principles for and components of a quality, 
cost-effective pharmacy benefit. Among other items, pharmacy believes 
that the best way to develop the Medicare pharmacy benefit for the 21st 
century would be to incorporate the following elements:

       Create transparency and full pass through of any 
rebates, discounts, or other price concessions received by 
administrators of the pharmacy benefit so that Medicare and seniors 
benefit from their purchasing power;
       Include policies that promote the utilization of 
generic drugs when appropriate;
       Provide seniors with access to meaningful, community-
based medication therapy management services with appropriate 
compensation for pharmacies;
       Give seniors access to the community-based pharmacy 
provider of their choice;
       Break down any artificial barriers created by drug plan 
administrators that impede competition and steer patients to higher-
cost brands or limit their choice of pharmacy provider;
       Do not economically coerce seniors to use other 
prescription delivery mechanisms, such as out-of-state mail order;
       Assure that community pharmacies are adequately 
compensated in providing services to meet the health care needs of our 
nation's seniors.
       Allow the intense competitive forces that exist among 
pharmacies and manufacturers to work to reduce costs without the 
interference of a self-interested middleman.

    We believe that these are among the most important principles that 
can be included in any future pharmacy benefit. We also want to 
describe for the Subcommittee some observations about trends in the 
marketplace that are important to consider as the Medicare pharmacy 
benefit debate moves forward.

FEHBP and DOD Use Different Approaches to Prescription Drug Benefit 
        Design

    The Federal Employees Health Benefits Program (FEHB) is often 
pointed to as the model for Medicare reform. Frankly, we believe that a 
more careful examination of the prescription drug benefit programs in 
FEHBP will give policymakers ample evidence to re-evaluate some of the 
major models being proposed that would rely primarily on pharmacy 
benefit managers (PBMs) to provide a prescription drug benefit.
    Anyone who is following the health policy, business, and financial 
news would find that important public health and public policy 
questions are being raised about the current practices of PBMs, and 
whether they are holding down drug costs, or responsible, in part, for 
their significant increases.
    The experience of the government's own FEHBP should be instructive 
to Members of Congress as they consider the true effectiveness and 
competitiveness of this approach to providing a prescription drug 
benefit for seniors. Our analysis indicates that escalating 
prescription drug spending in the FEHBP program--which is administered 
by some of the same PBMs that would be used for Medicare--has 
contributed significantly in recent years to the sharp premium 
increases seen in the program. In fact, these PBMs have a poor track 
record in managing FEHBP drug program costs. For example, the Office of 
Personnel Management's (OPM) own data indicate that drug cost increases 
were responsible for 40 percent of the 10.5% premium increase in 2001, 
37 percent of the 13.3% premium increase in 2002, and 30 percent of the 
11.1% premium increase in 2003.
    Keep in mind that the average age of the FEHBP population is about 
47 years of age, while that of traditional older Medicare population is 
about 70. Medicare beneficiaries have more chronic conditions, 
requiring greater drug use, which results in higher per capita 
expenditures than the much-younger, healthier FEHBP population. For 
example, the average Medicare beneficiary uses four times more 
prescriptions--about 21 prescriptions each year--than the average 
individual under 65 years of age, who uses about 5. If the PBMs have 
not been able to manage prescription drug spending in the FEHBP 
program's younger, healthier population, why should we believe that 
they would be any more effective in the higher-cost Medicare 
population?
    A recent General Accounting Office (GAO) report \1\ found that PBMs 
would not disclose the amount of rebates and other price concessions 
that they receive from drug manufacturers. These price concessions take 
many forms and have many different names. The bottom line is that the 
Medicare programs, seniors, and taxpayers should benefit from these 
financial incentives, and the best way to assure that they are passed 
along is to require transparency in their reporting by the PBMs. We 
urge that such provisions be included in any final Medicare pharmacy 
benefit program.
---------------------------------------------------------------------------
    \1\ GAO Report on Federal Employees' Health Benefits: Effects of 
Using Pharmacy Benefit Managers on Health Plans, Enrollees, and 
Pharmacies, January 2003.

PBMs' Anti-Competitive Practices Not Aligned with Goals of Payors or 
---------------------------------------------------------------------------
        Medicare

    Any Medicare pharmacy benefit for the 21st century should emphasize 
choice and access. These goals can only be attained if the structure of 
the pharmacy benefit breaks down many of the artificial, anti-
competitive barriers erected by the PBMs. Many public and private 
payors are rethinking their PBM strategies because they recognize that 
PBMs have overpromised and underdelivered. The goal of payors to reduce 
prescription drug costs is not necessarily aligned with that of the 
PBMs, which is to drive manufacturers rebates to gain higher operating 
profits for the PBM. These rebates are generated by promoting the use 
of higher-cost brand name drugs. What follows is an excellent example 
of how rebates create perverse incentives and anti-competitive 
practices in the marketplace:

      Most PBM-administered prescription drug benefit plans have both 
a community retail pharmacy network and a mail order pharmacy component 
(i.e. Medco, Express, Advance PCS, Caremark). In most cases, these mail 
order pharmacies are owned by the PBM, and the PBM uses the patient-
identifiable information that they obtain from processing a retail 
pharmacy claim, to switch patients to their own mail-order facilities.
      The PBMs have financial incentive to do this because they 
receive significant rebates from brand name manufacturers for moving 
(or increasing) a particular manufacturer's market share, so the more 
product that is dispensed through mail, the more rebates the PBM 
receives. This is not always cost-effective for the payor or the 
patient, since it increases copays for the patient and overall costs 
for the payor. Moreover, the retail pharmacy doesn't receive rebates 
and has no incentive to provide higher-cost brand name drugs.
      In fact, retail pharmacies use more lower-cost generics than 
mail, so the net cost to the payor and the patient is actually lower 
for drugs dispensed through retail. (Latest data found that mail order 
uses 37% generics, while retail uses generics in 49% of the cases).
      But, to force patients to obtain their brand name drugs through 
mail, these PBMs artificially limit the quantity of brand name drugs 
that a retail pharmacy can dispense.
      That is, while PBMs may incorrectly contend that State pharmacy 
practice laws prohibit retail pharmacies from dispensing a 90-day 
supply of medications, this is not the case. Some States do have limits 
on the amount of controlled substances that can be provided, but these 
restrictions would occur for any pharmacy outlet that dispenses these 
drugs. PBMs, however, will not allow pharmacies to provide any more 
than a 30-day supply because they want to run those prescriptions 
through their mail order facility so they can collect the manufacturer 
rebates.
      Mail order operations are direct competitors to community 
pharmacies. PBMs should not be allowed to use information obtained 
through a retail prescription claims transaction to switch patients to 
mail order for their own financial gain. To avoid this anti-competitive 
practice, PBMs should not be allowed to be both the community pharmacy 
network contractor and mail order contractor within the same region, 
since this creates a competitive conflict with community retail 
pharmacies. In addition, pharmacies should be allowed to continue to 
provide maintenance medications to patients (i.e. fill a 90-day supply 
of maintenance medication). PBMs should not contractually prohibit 
pharmacies from providing these medications. PBMs should not use any 
coverage or cost sharing incentive that would create incentives for 
seniors to use one method of pharmacy distribution over another.

    Some of these anti-competitive issues can be addressed by including 
strong ``transparency'' provisions in the Medicare pharmacy benefit. 
Pricing transparency is necessary for the efficient operation of 
markets, and also allows consumers and others to make the best 
purchasing choices. Right now, the PBM industry is operating without 
this necessary transparency.
    The Medicare program and seniors should benefit directly from any 
and all price concessions given to plan administrators and PBMs. These 
price concessions take many forms--rebates, discounts, formulary 
placement fees, market share movement fees, data collection and 
analysis fees, and others.
    If made transparent, and passed along, these incentives will 
ultimately reduce the cost of the benefit to Medicare and to seniors. 
It will also reduce the incentives that PBMs have to erect these anti-
competitive barriers that increase cost and can negatively impact 
quality of care.
    The PBM industry argues against transparency because they know it 
will more fully expose that their business model centers almost 
exclusively on deriving and retaining rebates from drug manufacturers 
that are not passed along to plan sponsors. We urge policymakers to 
make sure that transparency is a hallmark of any Medicare pharmacy 
benefit.

Department of Defense (DOD) Recognizes PBM Influences

    In contrast to the FEHBP program, which relies on private sector 
PBMs, the DOD's Tricare program has developed prescription drug models 
that are more cognizant of the negative influences of PBM rebates. 
Their approach uses a pharmacy benefits administrator (PBA) type model, 
which is the approach being taken by more and more public and private 
sector payors.
    The PBA model relies on a benefits administrator to adjudicate and 
pay claims, determine eligibility, create networks, and perform other 
operational functions to run the program. The PBA doesn't become 
involved with direct rebate negotiations with manufacturers, and is 
therefore not in a position to retain these rebates or develop policies 
that would encourage the dispensing of drugs for which they are 
receiving rebates.
    For example, the Tricare National Mail Order Program (NMOP) program 
passes along to DOD all the rebates that the DOD negotiates with 
pharmaceutical companies. This program is administered by Express 
Scripts, so even the traditional PBMs are able to participate in models 
that use PBA-type approaches. Building on the success of the NMOP 
program, DOD recently announced that its Tricare national retail 
pharmacy contract would operate in a similar manner. The DOD has 
recognized that PBMs retain a significant portion of manufacturer 
rebates and want these rebates to accrue to the DOD and the military 
eligibles and retirees. Thus, there are two major Federal Government 
health care programs using different approaches--with very different 
outcomes--to provide pharmacy benefits to two important populations.
    NACDS and community pharmacy support approaches to delivering a 
Medicare pharmacy benefit that take the perverse rebate incentives out 
of the system, since it results in nothing more than limiting seniors' 
access to needed medications and the pharmacy of their choice.
    Medicare, seniors, and taxpayers would all benefit from a system 
where any manufacturer or pharmacy price concessions are passed along 
to the senior, and anti-competitive incentives to dispense larger 
quantities of brand name medications or restrict the use of generics 
are eliminated.

Marketplace Has Responded with Discounts for Low-Income Seniors

    We believe that the market has changed significantly since the 
Department of Health and Human Services (HHS) announced its original 
Medicare-endorsed PBM-based discount card program in July 2001. For 
example, manufacturers now offer prescription drug assistance through 
participating retail pharmacies. These programs include ``Lilly 
Answers,'' ``Pfizer's Living Share Program'' and the ``Together Rx 
Program'' all of which assure that truly needy low-income seniors are 
able to obtain meaningful savings on brand name prescription 
medications at their participating local pharmacy.
    These private-sector approaches obviate the need for government-
mandated programs on the private sector. Over 150 brand name 
prescription drugs are available at discounts of up to 40 percent. In 
fact, the best competition occurs in the market when manufacturers and 
pharmacies compete without the interference of a middleman PBM that has 
the government's sanction to create artificial barriers to competition 
in the marketplace.
    By HHS' own estimate, their Medicare-endorsed PBM-based discount 
card program, such as those envisioned by CMS, would only generate 
savings of 10 to 13 percent for seniors on the cost of their 
prescriptions. Almost all of these savings would come from reduction in 
the prices that pharmacies charge, not a reduction in the price that 
the manufacturer charges the pharmacy for the drug. Moreover, these 
discount card programs--which already exist in the market--overuse 
higher-cost brand name drugs, rather than lower-cost generics. That is 
because PBMs earn rebates from drug manufacturers by promoting the use 
of their brand name drugs. These practices lead to higher prescription 
drug bills for seniors, not lower ones.
    Under a Medicare-endorsed discount card program, seniors' access to 
needed prescription medications and their choice of pharmacy would be 
restricted. Under these other newer programs, however, seniors do not 
have to make choices between various discount programs, switch their 
medication from a drug they may be taking to another drug just to get a 
discount, and don't have to give up using their local pharmacy. In our 
opinion, this is better health care for seniors.
    We would ask that you reconsider your approach to legislating a 
Medicare-endorsed discount card program that would be of little benefit 
to seniors and would significantly harm community pharmacies. Instead, 
we ask that you work with us to assure that private-sector approaches 
continue to be developed, which will help seniors obtain their 
prescription medications in the short term, while we work on a model 
for longer term Medicare reform that incorporates these important 
private-sector approaches.

Conclusion

    NACDS believes that the Subcommittee is asking the right questions 
regarding the best way to structure a Medicare prescription drug 
benefit that will serve the needs of Medicare beneficiaries and 
pharmacies in the 21st century. Contrary to popular opinion, today's 
market for prescription drug benefits has structural flaws that are 
being recognized by many public and private payors as impeding 
competition and unnecessarily increasing costs. These payors are 
responding by taking their benefit management functions in house, or by 
using a pharmacy benefits administrator (PBA) model. We believe that 
any pharmacy benefit should rely on the competitive market forces that 
already exist among pharmaceutical manufacturers and retail pharmacies, 
and that artificial barriers should not be erected to impede this 
competition.
    The Committee should also take note of the market shift that 
appears to be occurring--both in private and public sector programs--
away from PBM models and toward PBA or in-house administration models. 
These approaches help assure that the plan sponsors reap the benefits 
of their purchasing power, rather than having it diluted by a 
middleman.
    In order to provide the most competitive pharmacy benefit possible, 
policymakers should assure that the following components are 
incorporated into the program: 1) transparency and pass through of all 
PBM-derived rebates, concessions, and discounts; 2) assurances that 
PBMs do not erect artificial barriers to seniors' access to the 
pharmacy of their choice, such as through restrictive networks, 
limitations on the quantity of medication that retail pharmacies can 
provide, or differential cost sharing to provide seniors with 
incentives to use mail order over retail pharmacies; 3) limits on the 
activities performed by PBMs so that they function more as PBAs, and do 
not become involved in patient care functions, which is the purview of 
the health professionals; and, 4) restrictions on the ability of the 
PBM to serve both as the retail network administrator and the mail 
order provider in the same region, which is an inherent conflict of 
interest since PBMs are direct competitors of retail pharmacies.
    NACDS and its member companies look forward to working with the 
Subcommittee and full Committee on developing this Medicare pharmacy 
benefit. Thank you for an opportunity to submit this statement.

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