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In Brief: Prescription Drug Benefits: Cost Management Issues for Medicare

This In Brief summarizes the findings of the AARP Public Policy Institute Issue Paper, Prescription Drug Benefits: Cost Management Issues for Medicare. , written by Peter D. Fox. Fox discusses issues that decision­makers would face in managing the cost and utilization of a fee-for-service prescription drug benefit in original Medicare. He draws on the experience of Pharmacy Benefits Managers (PBMs)-private firms that administer drug benefits on behalf of employers, insurance companies, health maintenance organizations (HMOs), state Medicaid programs, and other organizations.

Key Findings

If Medicare covers outpatient prescription drugs, it will face the following benefit design issues:

  • Which drugs should be covered? The Medicare drug benefit either could cover all FDA-approved drugs or restrict certain types of products from coverage. Coverage decisions would require difficult value judgments. For example, questions may be raised about whether Medicare should cover drugs treating conditions that could improve the quality of life but might not always be considered medically necessary; e.g., drugs to treat male pattern baldness, sexual dysfunction, or skin conditions. Decisions also will need to be made about covering drugs that offer significant therapeutic benefits only for a relatively small population whose members cannot use less costly, therapeutically equivalent alternatives. Decision­makers will also have to address the coverage of drugs that are costly but marginally effective; those that have over­the­counter equivalents; and those that have not been thoroughly tested for use by older persons.
  • How broad should the pharmacy network be? Policymakers designing a Medicare drug benefit will need to assess the tradeoff between broad access to pharmacies and the ability to achieve greater savings from a narrower pharmacy network. A broader network provides greater choice to beneficiaries regarding where and how to fill their prescriptions. However, private sector purchasers often are able to reduce pharmacy costs by 2 percent to 3 percent if they contract with only 80 percent to 90 percent of pharmacies in a given area.
  • To what extent, and how, should beneficiaries be encouraged to obtain generic, rather than brand name, drugs where they are available? Most health plans encourage the use of less costly generic drugs through lower cost-sharing or by requiring the enrollee to pay the difference between a generic and a brand name drug. However, some plans waive any financial penalty if the doctor requests that the prescription be dispensed as written or can justify the medical necessity of dispensing by brand name.
  • For drugs with no generic equivalent, to what extent, and how, should beneficiaries be encouraged to obtain less expensive brand name drugs that are determined to be equally effective? Private sector plans generally have formularies-lists of drugs that are favored or approved for payment-to encourage the use of effective, less expensive alternatives within a given therapeutic category of drugs. Design of a Medicare drug benefit will require decisions about how restrictive a formulary should be and what types of incentives should be applied to encourage formulary compliance. The effectiveness of a formulary affect the price that Medicare would pay for drugs, since drug manufacturers tend to grant higher rebates to plans that are able to successfully promote use of their drugs over therapeutically alternative products.
  • How should prescription drug utilization be managed? Utilization management should address quality as well as cost. Such management can occur at three points in the transaction: (1) before a drug is dispensed; (2) at the time a prescription is filled; and (3) through claims analysis after the prescription is filled. For Medicare, it will be particularly important that utilization review identify patterns of underuse and overuse of medications.

Other issues addressed in the paper include:

  • To what extent, and how, should use of mail order pharmacies be encouraged?
  • Should Medicare contract with a single PBM to administer the prescription drug benefit within a given region, or with multiple PBMs (with the beneficiary making the ultimate selection)?


If Medicare covers prescription drugs, a myriad of decisions regarding drug coverage, reimbursement, and utilization management will need to be made on an ongoing and timely basis. Fox suggests that such operational decisions might best be made by an independent body or commission in order to insulate such decisions from political considerations. He cites two models where independent commissions have been used successfully: (1) the Defense Base Closure and Realignment Commission, which has been charged with recommending the closure of specific military facilities, and (2) the joint consumer-insurance industry committee convened by the National Association of Insurance Commissioners to determine the standardized benefit packages under the 1990 Medigap reform legislation.

Finally, Fox urges that the federal government be aware of private sector impacts of policies associated with a Medicare drug benefit, such as the potential to shift costs to the private sector and the potential to promote monopolistic behavior, such as by channeling a very large volume of claims through any one PBM.


  1. AARP Public Policy Institute Issue Paper #2000-09 (August, 2000).

Written by David Gross, AARP Public Policy Institute
August 2000
©2000 AARP
May be copied only for noncommercial purposes and with attribution; permission required for all other purposes.
Public Policy Institute, AARP, 601 E Street, NW, Washington, DC 20049

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