Note: I have updated some of the numbers here for 2021.
In recent posts, I have discussed viewing the selection of Medicare Part B Medigap and Part C Advantage plans as a set of probabilistic “bets” that you are making with your money against your health. This post extends that idea to Medicare Part D prescription coverage plans that were first instituted in the early 2000s during the George W. Bush administration.
In Huckleberry Finn, Mark Twain used an old British Cockney saying about money and risk: “You pays your money and you takes your choice!” Compared to the other Medicare cost protection plans, the Part D plan providers have a relatively-simple mathematical odds machine going in each of their plan offerings. And like in Las Vegas, the advantage goes to the house.
The probabilities of the Part D plan outcomes firm up nicely for providers because of four factors:
- A large but finite set of prescribed drugs that each plan covers, with known prices and patterns of consumption.
- A large, relatively stable (for the successful plans), customer population.
- A small number of plan options from any one provider.
- Government subsidies for the poorest and the high-cost, “outlier” customers, effectively “re-insuring” top and bottom ends to limit risk.
After a few years of historical data and some industry trend prediction, slight overestimates are offset by underestimates and then math’s Central Limit Theorem takes over, which says that even seemingly random events begin to form predictable outcomes over time. In other words, while your costs may vary by a lot in a year, the plan providers’ costs may not. 
Bet #1 – Can you “beat the house”? And so, the first assumption I suggest in evaluating plans is to realize that the plan providers know the math better than you do. It is very difficult to “beat the house.” For instance, you may hit the age of 65 without taking any prescription medications, and so you decide to defer selecting a Part D plan. When you finally do join a plan, however, you will likely be assessed a “late enrollment penalty” which raises your monthly rate until you die.
The late penalty is typically 1% of the “national base beneficiary premium” for each month that you have been uncovered by some kind of prescription plan. That penalty adds up quickly, and if you plan to around a long time yet, the plan providers will most likely get that money back from you, and then some. This is a variant of the bad bet I noted regarding Part B Medigap plans, the assumption that things relating to your health won’t change. The odds are that you will be prescribed some ridiculously-priced drug at a time you least expect it.
Bet #2 – Playing the drug price tiers. One side effect of the Medicare Part D prescription plans, aided by the consolidation of private insurance prescription plans into a small set of “near-cartels,” is the feature of tiered pricing. Most of these plans work by divvying up drugs into a “formulary” consisting of (usually) five “tiers” of coverage relating to the drug’s price and to the statistical likelihood that the drug will be prescribed.
For instance, the bottom tiers will include many older and generic drugs. These drugs are going to be priced quite low, sometimes near the cost of dispensing alone. The prescription plan providers can easily predict these costs after deductibles. The top tier will include very expensive “specialty” drugs. Even in the best plans, this tier usually involves a percentage “coinsurance” split between the provider and the consumer based on that price, with the consumer paying anywhere from 25% to 33% of the cost.
It is in the middle tiers where the interesting drug pricing action is happening. These are often the popular but expensive drugs that you see advertised on television (cheap drugs don’t get advertised). Different plans place different drugs in each tier, so you need to look for a plan that includes any drug that you take in a reasonably-priced tier. 
These tiers create a kind of catastrophe function for you, the consumer (but not the plan provider). The cost of the drug to you could easily jump from $40 per month if the drug is in your plan’s lower tiers, leaping right up to $400 per month if it is one tier higher. Most seniors can handle an extra $500 annual drug bill if necessary, but a surprise $5000 drug bill is going to take half of someone’s Social Security income for the year.
The higher cost plan offerings put more drugs in the lower-priced tiers, and there is your bet. You likely do not know what drugs you might be prescribed in the near future. The plan providers are doing constant statistical analyses to determine which drugs they can afford in each tier, based on the price of the drug and the probability of you needing this prescription. Over thousands of customers, this is pretty easy math for them. The pain comes, however, when you guess incorrectly.
Bet #3 – Betting that you have alternatives. As with the other Medicare plans, people who are most stretched for cash feel forced to choose the cheaper plans. And not coincidentally, these are usually the same people who cannot afford the costly prescriptions when they hit. I have witnessed seniors just walk away from the pharmacy counter when they are told the price. The system still sucks.
If you are in that boat, there may alternatives. For instance, the cheaper plans often have high deductibles. You can “self-insure” against an unexpected deductible by sticking $20 or $40 monthly into a “rainy day” envelope to be used only when the deductible hits. There is a good chance that you will have money left in the envelope at the end of the year and you save on the monthly premium.
Many expensive drugs have generic equivalents or near-equivalents, which requires an honest conversation with your doctor. If your doctor is not good at that discussion, you may need a different doctor. Finally, specialty pharmacies and discount websites are popping up that somehow manage to get costly drugs at a substantial discount. It pays to shop around, but waiting until you really need some drug is the worst time to have to confront this scramble. And you are taking the risk of the unknown supplier, which may be a risky bet.
Bet #4 – The “doughnut hole” bet. Once you and your plan have spent $4,130 on covered drugs in 2021, you will enter the famed “doughnut hole,” officially the coverage gap, where your costs per prescription could rise precipitously. The math gets complicated, and the more expensive prescription plans may provide better coverage during this gap. Essentially, this was an unfunded actuarial gap between what is basically “normal senior” expectations and “catastrophic coverage” funding kicking in, currently (2021) at $6,550 of spending.
The Affordable Care Act from the Obama administration gradually reduced the impact of the doughnut hole down to its minimal 2021 level, but there still may be cost impacts for seniors who hit this level of prescription costs without adequate Part D coverage. The higher-priced plans can moderate some of this hit, but the only option for cash-strapped seniors may be, as with deductibles, to “self-insure” by sticking more cash in that envelope every month. “Paying yourself” a small amount now may be less costly than paying a big hit to the pharmacy later.
“You takes your choice.”
Because of the “catastrophe function” characteristics of prescription pricing, even under cost these protection plans, my advice is, “How will you sleep better?” For many, if not most, that means to bite the bullet, accept the high odds of requiring expensive drugs, and pay for a plan with broad coverage. The alternative is, as Dusty Springfield sang, “Wishin’ and hopin’ and thinkin’ and prayin.’” This blog is called “When God Plays Dice” for a reason.
- I created an interactive demonstration of the Central Limit Theorem in this post from 2018. You can simulate what happens when you make hundreds of throws of a “wonky die,” one that has a “6” on one side but has blanks on the other five sides. The classic “normal curve” begins to appear from a seemingly-lopsided probability after enough throws.
- The common existence of these tiers appears to be having an interesting dual effect on pricing by drug manufacturers. They have access to the same math as the plan providers. If they price the drug too high, a plan provider may kick their drug up to the next-higher tier, hurting sales and angering customers. They are allowed to do this in the middle of a year if they cover you for the rest of the year at the lower price. However, there is also no great incentive to price too low. This creates what is called “foregone revenue,” the money the manufacturer could have made at a higher price that would still keep them in the tier. Prices from different manufacturers and drugs then naturally tend toward similar “tier prices.” It is a form of price collusion, but nobody has to say a word.
Rick, this series of posts raises a hopelessly naive question: “Why are the ‘choices’ in health insurance best described as bets?” I fear that the answer is that it’s more profitable for insurance companies to market plans as casino games rather than as genuine insurance. When people pay for options that provide very little protection for very big risks (cancer for a 20-year-old, say) insurance companies win big. Even though the premium is rather small, the chances of the insurance company paying out a really big claim are practically nonexistent. In casino games, only the customers gamble. An insurance regime with very broad coverage and no choices would be a much better deal for customers as a whole.
I have a good friend who “bet wrong” with a cheap Medicare Advantage only to find out that treatments normal Medicare with a good Medigap program would mostly cover would put them 10s of thousands in debt. And once you learn that, you find you are in the “Hotel California” and you cannot leave, as the Medigap programs now get to put you into “underwriting.” If if you are currently undergoing cancer treatment, you cannot afford the new price.
We indeed have turned medical care into a deadly financial game of chance, focusing on people’s worst impulses to save a buck, or worse, spend money they cannot afford.
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