“Beneficiary Price Sensitivity in the Medicare Prescription Drug Plan Market,” Frakt, Pizer (2009)

This is part of an occasional series of posts on my academic publications. I’m working backwards chronologically (roughly) and will, in time, summarize all of my 15+ publications to date. All posts in the series are listed under the Journal Articles category.

Stand-alone prescription drug plans (PDPs) became available under Medicare in 2006. No similar product had existed before in any market (i.e. drug coverage separate from insurance for non-drug medical care). Therefore, it was not known how consumers would behave. What would drive their enrollment decisions? How sensitive to price (or premium) would they be?

Answers to such questions were available for more conventional health insurance products. In particular, in terms of economics jargon (which I’ll immediately unpack) it had been found that the price elasticity of demand for Medicare HMOs with respect to premium was in the -0.33 to -0.12 range. What does this mean? It means that if the premium for an average Medicare HMO goes upby 10% then the number of enrollees in that HMO is expected to go down by somewhere between 3.3% and 1.2%. (For more on elasticities see What Is the Source of Price Setting Power.)

Demand responses to price lower in magnitude than one, as is the case with Medicare HMOs, are called “inelastic.” That term suggests a low degree of responsiveness to price. Medicare beneficiaries are relatively “sticky” when it comes to HMOs. There are no systematic large flows of beneficiaries from one plan to another. Enrollees stay put, more or less.

In a 2009 paper with Steve Pizer titled “Beneficiary Price Sensitivity in the Medicare Prescription Drug Plan Market” (Health Economics), we estimated the price elasticity of demand of PDPs for the year 2007. As I said, this was something that couldn’t have been done before because PDPs didn’t exist. We found that beneficiaries were much more sensitive to premiums in the PDP market (in 2007) than they were in the HMO market. The elasticity of demand with respect to premium was -1.45. If an average PDP raises its premium by 10%, enrollment for that PDP will decline by 14.5%. Since the elasticity is over one in magnitude, this is an “elastic” response.

Why are Medicare beneficiaries much more sensitive to price in the PDP market than the HMO market? There are a number of differences between the two markets that might explain (or are consistent with) this finding. First, PDPs do not have to contract with providers (hospitals, doctors) so the cost of establishing a PDP is lower than for an HMO. This explains why there are so many PDPs available to beneficiaries (about 55, depending on location). In contrast, there are far fewer HMOs available. Some markets have none. A big market might have a dozen. With so many PDPs relative to HMOs, there are more products that are similar to one another (or substitutable). Therefore, beneficiaries are more sensitive to price because they can be. They can find similar products much more easily in the PDP market than the HMO market.

Second, PDPs are relatively new products, and beneficiaries may not have yet established strong ties to specific plans. Hence, beneficiaries in the PDP market are more sensitive to all product characteristics, including premium, than are enrollees in the Medicare HMO market.

Finally, one can switch PDPs without changing doctors. That may not be so for an HMO. If your doctor has contracted with HMO A and not B and you switch from A to B you’ll have to find another doctor. That tends to lock beneficiaries into HMOs but is not a concern for PDPs.

It will be interesting to see if the price elasticity of demand for PDPs changes over time, perhaps moving closer to that for HMOs. This is what one would expect as the market matures and beneficiaries establish relationships with specific products and firms. For the reasons described above, however, I would not expect the PDP elasticity to ever be as low in magnitude as the one for HMOs. The  products are just too different and so are the markets in which they compete, at least right now.

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