In his classic 1975 book titled Equality and Efficiency: The Big Tradeoff, economist Art Okun noted the tensions between the political principles of democracy and the economic principles of capitalism. Some decisions yield more equality with less efficiency, and some yield more efficiency with less equality. Brilliant.
In 2018, a team of economists at the University of Southern California’s Schaeffer Center for Health Policy & Economics reported that 23% of pharmacy prescriptions filled by commercially insured patients in 2013 exceeded the average reimbursement from PBMs to retail pharmacies. The USC team’s supporting video and related press coverage suggested impropriety on the part of payers. Myopic.
For a more comprehensive understanding of cost sharing, it is instructive to trace the history, understand the objectives behind cost sharing, review some economic theory, consider equity-and-efficiency tradeoffs, and focus on the true challenge.
The history
Copayments, coinsurance, and deductibles emerged in the 1950s when private insurers competing with the Blues introduced major medical plans. Such cost sharing enabled insurers to improve access to care by covering more services with a premium that was comparable to the prevailing first-dollar coverage offered by the Blues. In response, the Blues started offering plans with these same cost-sharing features. Cost sharing has always been a means to maintain or expand access and to manage costs. Arguments for and against cost sharing are as old as cost sharing itself.
The objectives
Payers still use copays and other types of cost sharing to help manage their pharmacy costs. By giving members some “skin in the game,” copays are meant to discourage unnecessary care and encourage adherence to necessary care. Copays and co-insurance are predictable sources of revenue that payers use to offset expenses, and this is reflected in the premiums. Does cost sharing of drugs and other services sometimes exceed the costs? Yes. But is such “overpayment” an objective? No. And, importantly, nor is ensuring that a member’s cost obligation is less than the full cost of the product.
The economic theory
Why, then, does cost sharing sometimes exceed the costs? That’s simple: It is more efficient. Take, for example, a common $10 copay for generic drugs. It is a nice round number. It is easy to communicate and understand. It is generally affordable. It is somewhat effective at reducing both overuse and underuse. But it yields many so-called “overpayments” because there are plenty of commonly-used generic drugs that cost less than $10 per month. The USC economists observed that overpayments were more likely on claims for generic versus brand drugs (28% versus 6%), and that the average overpayment was $7.69. While not explicitly stated in the report, it appears that these overpayments typically live within the common $10 copay for generic drugs.
It is unfortunate that the USC economists focused only on the downside of such transactions but failed to point out the upside — that cost sharing lowers or slows the increase of premiums. It is also unfortunate that the USC economists used the charged term “clawbacks” to describe such overpayments. And it is unfortunate that the USC economists were overly simplistic when suggesting that the insurer or PBM pockets the difference — failing to acknowledge the administrative and transaction costs they incur.
The USC team discussed only overpayments, never mentioning “underpayments” — and this reveals their unstated but clear presupposition that copayments should be less than the total cost of the drug. When some patients pay more than the total cost and some pay less, then there are cross-subsidies across patients.
Are there alternatives to such cross-subsidization? Of course. Conceivably, copayments could be patient-specific or drug-specific. But how would that be assessed? And would that be equitable and/or efficient? Another option would be to increase the current cross-subsidization from those not taking drugs to those taking drugs. Alternatively, co-insurance, often reserved for specialty tiers, could be used for nonspecialty tiers. Doing so would help ensure (but not necessarily guarantee) that the amount paid does not exceed the total cost of the drug.
The RAND experiment demonstrated that demand for health care is elastic (i.e., as cost-sharing goes up, utilization goes down). While most people with high cost sharing did not experience worse outcomes, the RAND experiment showed how cost sharing negatively impacted lower-income people. In the 40 years since the RAND findings were published, there has been ample evidence to show that cost sharing can have negative impacts on patients with lower or fixed incomes, particularly those with chronic conditions, multiple conditions, and conditions requiring expensive treatments. Payers share these concerns, and they welcome patient-assistance programs designed to help people that qualify for financial assistance.
The USC economists’ estimate of savings makes no attempt to estimate the economic incidence of overpayments. A more rigorous assessment may conclude that overpayments yield savings for nearly all commercially insured lives.
The equity-and-efficiency tradeoffs
When payers make cost-sharing decisions, equity-and-efficiency tradeoffs are inevitable. Some cost-sharing designs may be more efficient but less equitable, and some designs may be more equitable but less efficient.
At first blush, charging everyone the same amount is more efficient but less equitable — it is regressive. But when the impact on premiums is part of the calculus, a more efficient cost-sharing design may lower premiums and, as a result, be less costly, more accessible, and (somewhat unexpectedly) more equitable.
Using co-insurance to charge everyone based on the cost of the product is even more regressive and less equitable — but efficient. While co-insurance for less-expensive drugs may be palatable and often less than copayments, many would find co-insurance for more expensive drugs to be less affordable than copayments.
Charging everyone based on ability to pay is more equitable — it is progressive, but less efficient. And what initially appears to be a more equitable cost-sharing design may increase premiums and, as a result, be more costly, less accessible, and, somewhat surprisingly, less equitable.
The true challenge
Eliminating overpayments is not the challenge. The challenge is to provide targeted relief to those who cannot afford cost sharing for medically necessary care. Whether cost sharing is an overpayment or an underpayment is immaterial. Meeting this challenge efficiently and equitably often requires a tradeoff. Payers can try to lead the way and develop solutions, but employers and their consultants will continue to make most of the cost-sharing decisions (good and bad) for commercial lives.
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