High-Priced Drugs in Medicare Part D: Diagnosis and Potential Prescription

Drug pricing in the U.S. is a persistently vexing policy problem. While there is agreement among many policy analysts that supra competitive prices are necessary to promote innovation; significant disagreements arise over how much pricing discretion prescription drug manufacturers should be permitted, and what portion of the sum of producer plus consumer surplus in the prescription drug market should be claimed by manufacturers relative to consumers and other payers. This paper focuses on an extremely costly component of the Medicare Part D program the region of coverage that kicks in once a consumer has spent $4,950 on drugs in a calendar year (roughly $8,100 in total drug spending). At that point there are high levels of insurance for the consumer and reinsurance for the prescription drug plan. Consumers pay 5% of costs; plans pay 15% and the government 80%. That design generates serious inefficiencies. The significant subsidies to plans in the reinsurance region combined with the launch of unique high cost prescription drugs could be expected to lead to and has led to substantial departures from cost-effective outcomes in treatments delivered.
We investigate two, possibly complementary, strategies for reducing these inefficiencies. The first follows on the MedPac recommendation that the government reduce its share of risk bearing for the Part D reinsurance benefit. The second focuses on curbing price inefficiencies. It has two components: eliminating monopolistic overpricing, and rewarding the quality of drugs brought to market. It is grounded in the economics of two part tariffs, research on innovation prizes, performance-based contracts, and draws on the mechanism design literature.