Private provision of social insurance: drug-specific price elasticities and pricing in Medicare Part D

Although optimal social insurance theory suggests that consumer cost-sharing should increases in a drug's elasticity of demand, publicly provided drug coverage typically involves uniform cost-sharing across drugs. Does the private market behave differently? We examine this question in the context of Medicare Part D. To do so, we first exploit the famous “donut hole” – at which insurance becomes discontinuously generous at the margin – to estimate drug-specific elasticities of drug demand with respect to its out-of-pocket price for almost 200 common drugs. We document substantial heterogeneity in the price elasticity of demand across drugs and diseases, with an average elasticity estimate of -0.28 and a standard deviation of 0.5. We then illustrate using a stylized model that, relative to a uniform consumer cost-sharing across drugs, private provision of insurance should move pricing in the direction of socially efficient contracts. We explore this prediction by exploring relationship between insurers' pricing decisions for each drug and the drug's estimated elasticity, using data on the contract design of hundreds of Medicare Part D plans. We present evidence that, on average, private insurance plans indeed appear to assign higher-elasticity drugs to higher tiers, with much of this relationship driven by assigning lower-elasticity generics to lower pricing tiers.