Sizing up the hurdles of Medicare Part D

Medicare Part D—the newly implemented prescription drug benefit of Medicare—has attracted a lot of attention since its official launch at the beginning of this year, and most would say the reviews are not good. Complaints and criticism abound, mostly from consumers, but many prescription drug providers are ready to argue that their challenges equal those of the beneficiaries they serve. Prescription Drug Plan sponsors face specific issues regarding plan design, pricing, liability valuation, and meeting the demands of government reporting requirements.

Rarely has a government-sponsored program caused such confusion among its participants and generated as much negative publicity as the new prescription drug benefit provided under Medicare Part D. Beneficiaries, federal and state officials, sponsors of private Prescription Drug Plans (PDPs), and pharmacists all have been forced to confront the magnitude and complexity of Part D. Principal among the concerns of consumers and drug plan sponsors are the program’s difficult-to-forecast costs and benefits.

Medicare Part D was envisioned as an insurance program that both protects participants from catastrophically high drug expenses and provides access to basic coverage for everyday prescription drugs, the cost of which can quickly sap the financial resources of many seniors. Yet, despite a federal government price tag of nearly $800 billion over the coming decade, the program features complexities that leave most seniors confused—and perhaps some even worse off than they were before. Several months into implementation, the chaos continues to grow.

A Hallmark moment

Consider just this sampling of evidence: One editorial page writer in a major daily newspaper recently dubbed the program "Dead On Arrival." Pharmacies and patients by the thousands are complaining about jammed phone lines at call centers, inaccurate computer lists, and overcharges resulting from a lack of clear instructions from the Federal government. AARP, one leading organization for retirees, has devoted a large part of the homepage on its Web site to helping resolve questions around Medicare Part D. In February, a Valentine's Day promotion in People magazine included a tear-out card for the Baby Boomer generation to send their aging parents, listing "Five ways to say I love you." In addition to a few somewhat predictable phrases, the card also offered, "Let's talk about Medicare prescription drug coverage."

The confusion started last fall when the 43 million people of all economic levels who were eligible for the program were encouraged to choose a plan. The premiums associated with the multitude of available plans vary widely, depending on covered drugs, participating pharmacies, and cost sharing. For some retirees, it seemed to make no sense to enroll at all, but if they chose not to enroll then, there would be a heavy penalty for joining a plan later.

With so many people involved and so many different options from which to choose, the amount of confusion generated is understandable—and perhaps should have been expected. Parallels can be drawn between the early consumer confusion and the current confusion being felt by the private PDP sponsors who are trying to make sense of their financial results several months into the program. Interpreting beneficiary response, financial data, claims activity—just to name a few challenges—is made all the more difficult for PDPs by the fact that there is no history against which to measure success or upon which to project future results.

PDP success will depend on finding solutions

It's important that PDPs clarify this ambiguity and overcome the challenges of this new market environment through use of sophisticated modeling and projection capabilities. PDPs that have the greatest probability of success as sponsors must now develop an understanding of their emerging experience on a month-by-month basis and then become as accurate as possible in their ability to project how that cumulative experience will unfold over the longer term.

Let's take a look at how confusion over this program developed in the first place and what drives its continuing evolution of complications, starting with the typical plan design:

• Most beneficiaries have an upfront deductible of around $250.
• After the beneficiary covers the first $250, they are then covered for up to about $2,000 in spending. Of that $2,000, about 75% of drug costs are covered.
• What follows is a big gap of almost $3,000 in spending, for which there is no coverage whatsoever for the beneficiary. (See accompanying article on "Climbing out of the Donut Hole.")
• After that gap, federal reinsurance covers 80% and the PDP sponsor covers approximately 15% of remaining drug costs. Beneficiaries who reach what is known as the "catastrophic layer" of drug expenditures are then only responsible for the remaining 5% of costs.

Rising drug costs made Part D a necessity

If one is diplomatic, the design is best described as strange. The fact is that the Part D program was 20 years in the making. When Medicare was enacted in 1965, the discussion began over whether to offer a prescription drug benefit. At that time, prescription drugs accounted for only 1% of total medical costs, so excluding them made more sense than it does today when they account for approximately 20% of every healthcare dollar spent in the U.S. To not have coverage now—particularly when pharmaceutical advances provide so much help to people who are dependent on them to live—would constitute a big void in Medicare's mission.

Questions arise when one considers that the program we’ve ended up with is not really designed to provide the most well-being possible. Rather, it is designed to balance the well-being it provides in a way that satisfies the parameters agreed upon by the lawmakers who fashioned Part D. Many will argue that it provides great value for the people who need it most—those in the catastrophic level of need and those who are eligible for additional coverage because of their income level. Others maintain that it provides relatively little financial relief to millions of seniors caught in the middle.

First, an overview of key issues

So how has this been working for PDP sponsors in the first few months of the program's inaugural year? Most will say that—from a financial standpoint—they had a very good first month (January) because beneficiaries were satisfying their deductibles and the PDPs did not have much liability. A lot of claims were processed, but members were footing most of the bills in plans that have a deductible. The PDPs' share of the pharmacy claims grew substantially in February, as people exhausted their deductibles and started to receive 75% coverage on eligible prescriptions. The typical PDP's share of the claims doubled, on average, growing from $40 pmpm (per member per month) to $80. The PDPs' share of total drug spending continued to rise in March and April; it will begin to drop once some of the beneficiaries' drug spending exceeds the initial coverage limit of $2,250 and the PDP sponsor’s liability decreases to 0% throughout the coverage gap (also known as the "donut hole"). We expect that, over the course of 2006, PDPs will be on a roller coaster ride with their share of incurred claims—a major departure from the predictable patterns of typical healthcare coverage. Confusing enough, perhaps, but in reality the challenges are just beginning.

The real challenge for the PDP centers on the "Four Hurdles of Part D": 1) ongoing increases in enrollments, 2) sheer numbers of plan options, 3) the problem of "dual eligibles," and 4) risk corridors.

1. Increases in enrollments   A lot of prospective beneficiaries took advantage of the advance enrollment period beginning last fall. But a sizeable number of potential new beneficiaries remain who have yet to sign up. The program is still in the open enrollment phase—and we don't know how many of those currently on the sidelines will eventually join or when they might decide to enroll (if at all). Overlay that uncertainty with the up and down pattern of claim payments mentioned earlier and the plot begins to thicken.

Consider the following key points regarding enrollment:

 The month of enrollment will have a major impact on profitability. The 11th and 12th months of coverage are expected to be much less costly for a PDP than the fifth and sixth months of coverage. PDPs will not have the opportunity to provide an 11th or 12th month of coverage in 2006 for anyone who enrolls in March (or later). This will drive up the average monthly cost of coverage (but there is no adjustment made to the direct subsidy or the beneficiary premium).

• Most PDP sponsors did not plan on the enrollment pattern that is emerging. Beneficiaries who enroll in May are likely to have a higher average monthly cost that is more than $25 greater than January enrollees. If a PDP was priced with $6 pmpm profit, those enrollees will generate a significant loss in 2006.

• Some experts expect healthier beneficiaries to enroll later in the year since prescription drug coverage may not be as vital to them as it is for beneficiaries with serious health conditions. However, there are risk adjusters in place as part of the initial program. These were developed assuming a standard plan design and 12 months of coverage, so the issue of an inadequate premium is still likely to occur during the inaugural year.

2. Different plan options   A number of national PDP sponsors have 102 different individual PDPs that they need to monitor (up to three different plan designs in each of the 34 regions), and a couple even offer plans in the U.S. territories. The pattern of coverage can vary with each plan design (e.g., some plans have a lower deductible or no deductible while others offer some form of coverage in the coverage gap) and the PDP liability is greatly affected by the plan design. Some of the plans being offered will provide approximately 50% of the total annual benefit (for a typical beneficiary) by the end of the fourth month of coverage; other plans will provide closer to 40% of the full year benefit in the same time span for the same beneficiary. Understanding how each unique plan is operating (and its impact on financial outcomes) requires precise calculations and complex monitoring systems. Managing the volume of data, on top of getting a handle on emerging claims experience (and the other challenges yet to be discussed), makes this area another big challenge.

3. Dual eligibles and the mix of beneficiaries "Dual eligibles" is a term given to people who qualify for both Medicare and Medicaid. Much of this population has a very high rate of drug utilization. While projecting claims for such a group can be handled by finance professionals, it is the mix of dual eligible participants combined with all other beneficiaries that creates a new and complex twist to projecting future costs. Traditional methods used to forecast the total cost of the Part D benefit are not likely to be sufficient to produce accurate claim projections for most Part D plans. This is because the standard approach to projecting health claims does not involve reshaping the assumed distribution of beneficiaries—only rescaling their projected spending level. The Part D benefit, however, requires this simplifying of assumption to be revisited due to the irregular benefit pattern.

4. Risk corridors   The federal government put risk corridors in place to protect PDPs' liability during the first year and thereby attract them to the new program. Each PDP provided the expected cost for beneficiaries in the bid that they submitted to the Centers for Medicare and Medicaid Services (CMS) for consideration. The bids that were submitted typically projected around $1,000 per beneficiary per year. If the full year actual results are within 2.5% of the projected amount, the risk corridors do not come into play. If the claim experience for the year is more than 2.5% higher than expected, the government pays the sponsor more money; if the claim experience is better (by the 2.5% margin), the sponsor must return some of the excess gain to the government.

This built-in risk protection does in fact reduce PDP sponsor risk, but it also adds one more layer of complexity that must be dealt with when projecting financial results. The PDP sponsor must perform their risk corridor calculations at the plan level in order to provide the granularity needed to accurately measure true results. Using the aggregate PDP sponsor results will usually mask the true outcome. The table above, which illustrates a 2% difference in earnings for one region for a sample PDP sponsor, highlights the disparity between the incorrect and correct methods of viewing results.

The heat is on

Most senior managers at PDPs want (and need) to know how the year is developing and how earnings are likely to develop for the next quarter and for the full year. In addition, PDP managers feel the heat of a fast approaching deadline for submitting 2007 bids, which will require reliable outlooks on the adequacy of the 2006 pricing. The deadline is June 5th. All of this together means it is essential for PDP sponsors to clear all four of the hurdles outlined above and draw key conclusions as to how their plan is running compared to how it was priced for 2006.

Admittedly, the four hurdles pose extraordinary challenges for actuaries, as well as for accountants and PDP sponsors. Milliman has taken a proactive role in helping sponsors deconstruct traditional models and develop new forecasting techniques in order to smooth out the complexities and solve the riddles of Medicare Part D.

Successful management of financial performance will depend on the PDPs' ability to monitor their experience on a timely basis, forecast how it will develop throughout the year, manage the program-based information, and comply with government reporting requirements. These steps are unquestionably essential to the successful management of a well performing PDP.

Steve Kaczmarek is a principal and consulting actuary based in Milliman’s Hartford office. He is a Fellow of the Society of Actuaries (SOA) and is on the American Academy of Actuaries Medicare Part D Actuarial Equivalence Work Group. Steve is a regular speaker at national conferences and will be presenting new actuarial techniques for Part D financial projections at the spring SOA meeting.