The Economics Department

Rising to the Surface in the Medicare Part D Debate

Rising to the Surface in the Medicare Part D Debate

“America finally has a simple solution to our seniors’ prescription drug problems. A voluntary enrollment system of tiered formularies run by private interests in which drugs may be differently tiered and have different copays in any of the dozens of similar plans seniors may choose from depending on their home state, age and employment background. Voila!”

— Stephen Colbert, The Colbert Report (2006)

When the Medicare Prescription Drug, Improvement, and Modernization Act went into effect in 2006, it did so amid heavy criticism of the plan’s complicated structure.  Senior citizens, critics claimed, would never be able to select the most affordable option for their specific prescription drug needs from a program that offered some 50 different plans, each with its own combination of annual premium, deductible, and drug coverage formulary.  Adding in the issues of age, dementia, and illness, many predicted that senior citizens would not be able to navigate the unwieldy system and would end up overpaying for their prescription coverage.

For Eugenio Miravete, Associate Professor in the Department of Economics, the seemingly messy Medicare Part D program was an ideal environment to study the economic implications of consumer learning and pricing services through menus of pricing options.  Together with researchers from Arizona State University, Cornell University, and University of Maryland, Miravete followed over half a million senior citizens’ Medicare D plan choices from 2006 to 2007.  In “Sinking, Swimming, or Learning to Swim in Medicare Part D,” a paper forthcoming in The American Economic Review, Miravete and his colleagues revealed that seniors adjusted better than many expected to the array of plan choices.

Studying the rate of overpayment, or the difference between what individuals actually pay and the very least amount of any of the 50 or so plan alternatives, Miravete’s team found that Medicare Part D participants were substantially reducing overpayments by the second year of the program.  Overall, payments were reduced by about $300 per person from 2006 to 2007, and less than 2% of the sample group overpaid significantly by their second year of enrollment.  Miravete explains that these results “run against the belief that consumers, and in particular elders, are unable to choose wisely. True, people make mistakes but they tend to self-correct over time, and that should be a relief for policy makers as no corrective policy or regulation of these contracts appears to be necessary.”

[The donut hole] is the reason why elders have an incentive to search for the least expensive plan.

Eugenio Miravete
Department of Economics

The main source of this improvement in overpayment was switching from one plan to another during the enrollment period for participants’ second year of coverage.  Reductions averaged 40-54% after just one year of participation in the program, and the more beneficiaries overspent in their first year, the larger their reduction tended to be for the second year.  Though initial doubts about the Medicare Part D program often centered around the performance of seniors with additional difficulties, such as advanced age, mental illness, and Alzheimer’s disease, the findings showed that these groups improved their overspending by as much as the average beneficiary. 

Though trial and error certainly contributed to seniors’ ability to control overspending, Miravete also points to an increase in information and support available for the 2007 plan year.  Government sponsored websites allowed seniors to search and compare the cost of various plans, doctors and pharmacies helped provide patients with personalized advice, and family members or caretakers stepped in to help with the selection process.  In cases of advanced age and dementia, family assistance has likely been a key player in reducing overpayment.

The infamous “donut hole,” another highly debated aspect of the Medicare Part D program, may have also contributed to seniors’ fast learning curve.  This coverage gap required seniors to pay 100% out of pocket for their medications once they reached a certain threshold of spending (approximately $2,500 - $5,000 in 2007).  Above the threshold, coverage resumed with only a 5% cost to the plan holder.   Miravete says the donut hole, though an unpopular concept, “is the reason why elders have an incentive to search for the least expensive plan.” 

The donut hole was designed to help suppress the cost of the program by encouraging seniors to choose their coverage plan wisely and to opt for generic drugs whenever possible, as well as by preventing pharmaceutical companies from raising prices unchecked.  As Medicare Part D has cost taxpayers 30% less than originally budgeted, the donut hole seems to have been a successful cost saving tool.  Under the Patient Protection Affordable Care Act, however, the donut hole will be phased out gradually and completely removed by 2020.  Based on his research, Miravete notes that the removal of the donut hole will “reduce the incentive for consumers to search [for the best plan], and it is very likely that overpayment will increase” and the total amount of government subsidy will skyrocket.

Regardless of the changes in store, Miravete’s Medicare Part D research remains a powerful illustration of market forces at work on a large scale.  “Medicare is an important market,” Miravete says. “People care about it, and data is abundant and of great quality. I cannot imagine a better application to test and debate the implications of learning and consumer pricing. If old, not very wealthy, and sick customers do not make systematic mistakes on something that matters a lot to them, we should expect that the same will happen among the general population on issues that matters to them.”

-Eugenio Miravete is an Associate Professor in The University of Texas at Austin Department of Economics.  Miravete's co-authors are Jonathan Ketcham from the W.P. Carey School of Business at Arizona State University, Claudio Lucarelli from Cornell University and M. Christopher Roebuck from the University of Maryland.