Wednesday, November 16, 2005

Wagering On The Future Of The Medicare Prescription Drug Benefit

by Tom Bozzo

Jeremy posted a surreply to my reply to his post on Krugman and the Medicare prescription drug benefit. He offers, and I accept subject to some clarification below, this friendly wager:
Understand that there are basically four parts to the "template" of the Medicare prescription drug plan:
(1) the first deductible (to $250 [0% coverage])
(2) the first coverage ($251-[$2250], 75% coverage)
(3) the second deductible ("the doughnut hole," [$2251]-$5100 [0% coverage])
(4) the second coverage ($5101+, 95% coverage)
My wager is that when people of the Rational Liberal stripe are talking about this bill five years from now, one part will be regarded as a bigger mistake than the others. And it won't be (3). It will be (4).
In one sense, I think I could declare victory now, since I doubt that many if any Rational Liberals would find themselves arguing that the providing a universal benefit for seniors' "catastrophic" drug expenses is a mistake for the reason that it's bad idea to offer that sort of insurance. Some form of catastrophic coverage, after all, has been the universal feature among the various Medicare prescription drug benefit proposals. Along those lines, I would be flatly shocked if, upon a Democratic return to political power, the inevitable reform of the benefit didn't somehow extend coverage into hole (3) while providing essentially the same benefit as current law provides for catastrophic range (4).

I will, however, pay up for a Democratic-sponsored reform plan (enacted or at least put to a vote) that addresses drug prices, partly because it's only beer at stake and partly because I totally agree with Jeremy that it would be good for the country if something serious were done about that. I will also pay up if the catastrophic part of the benefit is specifically implicated in a general fiscal crisis worse than the current situation, though I reserve the right to compare costs for parts (2) and (4) of the coverage. I win if benefits are extended into the hole unless accompanied by a measure to allow Medicare to use its purchasing power to negotiate lower drug prices. If a reform package simultaneously extends benefits into the hole and reduces costs out of the hide of Big Pharma, we both win and spouses and/or significant others are forewarned that designated driver services may be required.
In terms of the automatic victory part, you're right insofar as I didn't do a good job of explaining what I meant. My apocalyptic vision (and I'm being half fanciful here, only half, but fanciful nonetheless) would be that of Rational Liberal recognizing that, yes, seniors needed to have catastrophic coverage, but, whoa!, we didn't appreciate the fiscal havoc that was going to wreak. Which I think is basically what you're saying above. The comparison of (2) to (4) toward that end is perfectly fine, because if it ends up that the bigger pathology is (2), it would require a really strong revision of my thinking.

I agree that it's an interesting matter what's going to happen with the hole. Too bad it's not like a movie where we can fast forward and see what happens.
Two things about all this that make me feel woefully underpowered in my thinking about the matter is that, while I do think the simplest way of explaining the doughnut hole is that it is a second deductible, I don't feel like I well enough understand reasoning behind regular deductibles. Does this basic logic of your argument apply to the first deductible in the plan as well, and it's just that people are only on the hook for $250 that it's not a pathology?

The other thing I can't really get my head around is thinking of all this as "insurance". The first coverage zone to me seems like a discount club more than insurance. Two big differences between this plan and how I normally think of insurance:

(1) normally, I think of insurance as being about uncertainty and the shifting of money from sunny days to rainy days. Here, there are people who will be enrolling in the plan who will be saving money from the day they sign up and saving money for the rest of their lives.

(2) normally, I think about insurance as me giving money to a company because something bad could happen where a big bill will need to be paid, and so I'll pay them small amounts of money if they'll agree to pony up the big money if it's needed. Here, the drug companies will actually be obtaining the drugs a good deal cheaper than what I will be able to obtain on my own. This is the first coverage zone seems to me more like a "discount club" than "insurance."
Jeremy: An ancient text you might check out is Kenneth Arrow's "Uncertainty and the Welfare Economics of Medical Care" in the American Economic Review from 1963 (you can probably get it online somehow or other if you're interested); here's a journal issue in its honor (ditto).

Deductibles aren't inherently pathological. In fact, they can arise in the absence of the usual asymmetric information problems as the optimal insurance contract under certain administrative cost structures.

It's possible to show that for an increasing sequence of potential losses X1, X2, X3... it's possible that an optimal contract insures X1 and X3 but not X2, but that requires a quite odd utility function.

As for the insurance vs. discount club issue, I do understand where you're coming from; certain institutional structures (HMOs) even explicitly blend the two. I guess why I come down on the "insurance" side is that losses in the first coverage range are not certain, even though it may be very common to run bills up into the range. Basically, for point (2), the economic theory focuses on the uncertainty and not the size of the bill; the latter in choice-under-uncertainty theory has more to do with how much of a risk premium the insured is willing to pay to restore financial certainty.

As for point (1), the subsidy from general government revenues arguably is the extraction of payments from "sunny days."
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