An Analysis of the Medicare Prescription Drug Benefit

Medicare has recently experienced the largest expansion of benefits since its inception: the inclusion of prescription drug coverage under the Medicare Prescription Drug, Improvement and Modernization Act of 2003. The policy debate has mainly focused on estimating the cost of implementing the new benefit, with little attention to the quantification of its impact on beneficiaries’ life expectancy, health status, and health-related behaviors. The policy came into effect in January 2006; therefore, no post-policy data are available yet. This paper develops and estimates a dynamic model of the demand for supplemental health insurance and different types of medical care, and uses the model to forecast the effects of the new Medicare benefit in a way that explicitly takes into account the policy’s unique actuarial design and the dynamic features it includes. The results show that the new policy increases expenditure on prescription drugs by 24%, and has a positive effect on health status and life expectancy. There is a corresponding increase in the utilization of inpatient and outpatient care, due to the extension of life for people in poor health. The cost of extending life by a year is estimated to be between $38,000 and $62,000. The take-up rate of the new benefit reaches 85% by the fifth year of implementation, and there is a sizable crowding-out effect of private plans offering supplemental prescription drug coverage. The dynamic model is also used to evaluate the impact of alternative designs for the prescription drug benefit.