Perverse Incentives in the Medicare Prescription Drug Benefit

David McAdams, Michael Schwarz

NBER Working Paper No. 12008
Issued in February 2006
NBER Program(s):Health Care, Public Economics

We analyze some of the perverse incentives that may arise under the current Medicare prescription drug benefit design. In particular, risk adjustment for a stand-alone prescription drug benefit creates perverse incentives for prescription drug plans' coverage decisions and/or pharmaceutical companies' pricing decisions. This problem is new in that it does not arise with risk adjustment for other types of health care coverage. For this and other reasons, Medicare's drug benefit requires especially close regulatory oversight, now and in the future. We also consider a relatively minor change in how the benefit is financed that could lead to significant changes in how it functions. In particular, if all plans were required to charge the same premium, there would be less diversity in quality but also less budgetary uncertainty and less upward pressure on drug prices.

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Document Object Identifier (DOI): 10.3386/w12008

Published: David McAdams & Michael Schwarz, 2007. "Perverse Incentives in the Medicare Prescription Drug Benefit," INQUIRY: The Journal of Health Care Organization, Provision, and Financing, vol 44(2), pages 157-166.

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