Incentives and Innovation: Pharmaceutical Research and Low-income Groups Under the Proposed Medicare Prescription Drug Benefit

• Publication year: 2003

Christopher Sean Jackson⁰

Competing visions of a Medicare prescription drug benefit often differ dramatically in their treatment of low-income groups.¹ The profound implications of this treatment spread far beyond access to medical care, even reaching the process of technological innovation through which new drugs are produced. Low-income subsidies² under proposed versions of the Medicare prescription drug benefit will significantly alter the incentives pharmaceutical manufacturers face, possibly resulting in the unexpected emergence of more innovative drugs from the R&D process as research focuses on the special needs of low-income groups.³

The different prescription drug benefit proposals highlight the impact of law and policy in shaping the course of science, healthcare, and the socioeconomic status of Americans. Among the many economic consequences of such a benefit, significant changes will occur in the technological innovation of new drugs as manufacturers respond and adapt to a different marketplace.⁴ Evidence suggests that two primary forces will drive research toward more innovative outcomes. First, better access to drugs for low-income Medicare beneficiaries will increase drug demand and ease financial pressure on pharmaceutical producers to boost profits via minor variations of existing product lines.⁵ Second, for a variety of reasons, aging low-income groups tend to be in poorer health than their higher-income peers, resulting in greater demand for technologically complex drugs.⁶

The Medicare prescription drug plan is a massive piece of legislation containing many controversial and complex provisions. This Recent Development will describe the impact of the treatment of low-income beneficiaries, including both "dual-eligibles"⁷ and the "near-poor,"⁸ on pharmaceutical innovation in the House and Senate proposals. If manufacturers shift the focus of their research toward more innovative technology, the resulting benefits to society will play an important role in offsetting the costs of such coverage.

In June of 2003, both Houses of Congress passed versions of a prescription drug coverage amendment to Medicare.⁹ Americans overwhelmingly support a prescription drug benefit provision; a 2003 survey indicated that sixty percent believed that Congress should enact some sort of drug benefit.¹⁰ Dramatic increases in drug-related spending over recent years have spurred political impetus for these plans.¹¹

Not only is growth in prescription drug spending increasing, but the drugs are increasingly costly.¹² Pharmaceutical spending growth jumped from 1.1% in 1980 to 8.2% in 1990, hitting an alarming 17% by 1999.¹³ Additionally, the Bureau of Labor Statistics calculated an average 4.9% increase in the producer price index ("PPi") for the pharmaceutical industry from 1987-2002, compared with an average 1.95% increase in the PPI across all manufacturing industries.¹⁴ in the absence of a drug benefit, average out-of-pocket expenditures for Medicare beneficiaries are projected to rise from $999 in 2003 to $1,454 in 2006.¹⁵

I. The Proposed Medicare Prescription Drug Benefit

In 2003, Congress attempted to address the increasing medical expenses of America's seniors by establishing a prescription drug benefit plan. Each house offered a different plan, and they currently are in committee debate as lawmakers attempt to reconcile key differences in the bills, such as the treatment of dually-enrolled beneficiaries.¹⁶ Legislators, however, are having great difficulty reaching agreement and a vote on the final version of the bill is difficult to forecast.¹⁷

At present, Medicare consists of Part A, which covers inpatient and critical access hospital costs, as well as short-term or rehabilitative nursing home costs, and Part B, which covers doctors' services and outpatient hospital costs.¹⁸ Beneficiaries enroll separately in the two parts, and there is no premium for Part A enrollees who paid Medicare taxes during their working years.¹⁹ Beneficiaries pay $840 for hospital stays up to 60 days, $210 per day for 60-90 days stays, $420 per day for 91-150 days, and all costs for hospital stays above 150 days.²⁰ The monthly Part B premium is $58.70 per month.²¹ Enrollees pay a $100 deductible per calendar year for medical services plus 20% of after-deductible expenses.²²

With limited exceptions, the Medicare plan does not cover prescription drugs.²³ Qualified beneficiaries may enroll in a Medicare + Choice plan at an extra cost and receive coverage for portions of prescription drug costs.²⁴ Additionally, certain Medigap plans offer some prescription drug benefits.²⁵ These plans typically are too expensive for low-income groups.²⁶ Medicaid offers a limited prescription drug benefit,²⁷ but Medicare beneficiaries with incomes or assets above approximately 74% of poverty do not qualify for Medicaid plans, and additionally may be unable to afford supplemental Medicare insurance.²⁸ These low-income individuals typically fall into one of several categories referred to as near-poor²⁹ and receive varying levels of subsidization under the prescription drug proposals. More than half of Medicare beneficiaries fell below the 200% line of poverty in 2001, amounting to more than 19 million beneficiaries.³⁰ only 5.8 million of these qualified for prescription drug coverage under Medicaid as dual-eligibles.³¹

The House and Senate plans share a number of common features, including voluntary enrollment, a universal drug benefit with significant support for low-income beneficiaries, monthly premiums of approximately $35, overall costs of approximately $400 billion over 10 years, and the creation of a new agency within the Department of Health and Human Services to administer the drug benefit.³² There are, however, significant differences. The Senate bill, S. 1, features a $35 per month premium with a $275 deductible and 50% coinsurance³³ between $275 and $4,500. Meanwhile, the House bill, H.R. 1, includes a $35 monthly premium and a $250 deductible, with a 20% coinsurance rate between $250 and $2,000. Above S. 1's initial coverage limit of $4,500,³⁴ beneficiaries must pay out-of-pocket until expenses reach the stop-loss threshold of $5,812.50. Then, Medicare resumes coverage with a 10% coinsurance rate.³⁵ This gap in coverage is known as the "hole in the doughnut."³⁶ H.R. 1 differs dramatically on this point, with an initial coverage limit of $2,000³⁷ and a stop-loss threshold of $4,900, a significantly larger hole in the doughnut.³⁸ Dual-enrollees in Medicaid retain their Medicaid coverage under S.1, and are not eligible for a Medicare drug benefit.³⁹ under H.R. 1, dual-enrollees may enroll in the drug benefit, with Medicaid serving as a wraparound.⁴⁰ The differing treatment of low-income individuals is of particular significance. S. 1 allows beneficiaries to qualify for "low-income" coverage at higher levels of income than H.R. 1, due to its exclusion of dual-enrollees. Thus, according to Congressional Budget Office ("CBO") estimates, the Senate plan would cover approximately 4.5 million fewer low-income beneficiaries.⁴¹ However, S. 1 gives its low-income beneficiaries significantly greater depth of coverage given the significantly higher initial coverage limit.⁴²

Since beneficiaries must live well below the poverty line in order to qualify for Medicaid coverage, dual-enrollees are significantly poorer than other Medicare beneficiaries. More than 70% of dual-enrollees have annual incomes below $10,000, compared to 13% of all other Medicare beneficiaries.⁴³ Those near-poor beneficiaries who do not qualify for Medicaid assistance are likely to either avoid the costs of more expensive medication or skip doses in order to prolong their supply of already-purchased prescriptions.⁴⁴

II. The Process of Pharmaceutical Innovation

The process of pharmaceutical innovation is both risky and costly, but with a potentially huge payoff both for the research firms and the society that stands to benefit from them.⁴⁵ For example, in 2002, Pharmaceuticals Research and Manufacturers of American ("PhRMA") estimated its domestic drug sales (for both prescription and over-the-counter drugs) at $145,213,400.⁴⁶ The U.S. pharmaceutical industry has increased its R&D expenditures as a percentage of domestic sales from 12% in 1970 to 18.2% in 2002.⁴⁷ Pharmaceutical manufacturers are highly sensitive to the projected demand for their products, given the high capital outlay required for drug research and the inherently risky nature of the process.⁴⁸ As a result of this high outlay, drug manufacturers do not charge the marginal cost of drug production, but instead allocate their total R&D costs by increasing the price of each pill that actually reaches the market.⁴⁹ The support a Medicare plan offers to low-income beneficiaries will dramatically shift demand for drugs consumed in large quantities by this population.⁵⁰ Accordingly, pharmaceutical research will direct itself toward this expanded market, possibly altering the level of innovation seen in new drugs, as manufacturers focus their research toward the needs of low-income consumers.⁵¹

The FDA classifies new drug applications ("NDAs") in two ways: chemical type and therapeutic potential.⁵² Drugs that offer substantial advances over existing compounds are given a priority classification, while those offering no significant improvement are given a standard classification.⁵³ NDAs with active ingredients that have never been approved by the FDA are termed new molecular entities ("NMEs"), those that feature an already-approved active ingredient or a slightly modified close chemical derivative are termed incrementally modified drugs ("IMDs"), and drugs with an identical approved active ingredient are "other drugs."⁵⁴ The FDA seeks to process priority applications within six months, whereas standard applications have a 10-12 month completion goal.⁵⁵

The relative levels of drug innovation can be inferred by this system...