August 23, 2011


Saving Medicare from Itself (AVIK ROY, Summer 2011, National Affairs)

But if price controls have been a failure, most attempts at market-oriented reforms have not fared much better. In 1982, Congress introduced Medicare Part C, which allows private insurers to administer Medicare plans at 95% of the combined cost of Part A and Part B. The idea was that these private plans could save money because they would integrate Part A and Part B coverage into a single benefit package, and would thus be managed more efficiently by private entities. Part C was popular with retirees; enrollment grew at 30% a year in the mid-1990s, peaking at 16% of Medicare enrollees in 1999. But unfortunately, this system strongly incentivized private plans to "cherry-pick" younger and healthier retirees, leaving the rest to traditional Medicare -- thereby raising, rather than reducing, overall costs (because the larger traditional Medicare program still dominated the health-care market, and so its higher costs meant higher health-care costs overall).

Things changed in 1997, when the Balanced Budget Act introduced a more sophisticated risk-adjustment system so as to curtail cherry-picking. As a result, insurers started to drop out of Part C (since their costs were going to rise), and enrollment stalled. It turned out that, for beneficiaries of equivalent health and age, private plans were slightly more costly than traditional Medicare, because the fragmented community of private insurers lacked the government's market power to negotiate lower rates. The fact that private insurers had to compete in the same market with traditional Medicare put them at an immense disadvantage, yet Medicare's market advantage did not make it any more efficient or cost-effective.

This problem was revisited in 2003, when President Bush signed the Medicare Modernization Act. The MMA increased reimbursements to private insurers in order to compensate for their lack of market power; by 2009, Part C plans (rechristened "Medicare Advantage" plans) were paid 14% more per patient on average than traditional Medicare. In return, private insurers reduced premiums. These changes increased the popularity of privately-managed Medicare plans; by 2010, Medicare Advantage enrolled 11 million retirees, or nearly 25% of all Medicare participants. But again, they did not significantly reduce costs, as they were still playing in a field dominated by a highly inefficient fee-for-service Medicare program.

Market-based reforms cannot have their desired effect -- introducing meaningful competition and consumer pressures to bring down costs -- as long as this traditional fee-for-service structure of Medicare remains the dominant force in the market, because providers still have a powerful incentive to conform their behavior to Medicare's inefficient design. For a market reform to work, it seems, it has to be comprehensive -- either replacing traditional Medicare or turning it into just one option among many. Today's reformers would be wise to keep this lesson in mind.

The most successful cost-control experiment in Medicare -- the relatively new prescription-drug component called Part D -- has been proving this point. The Part D benefit, added in 2003, is a so-called "premium support" program. Seniors are given a set amount of money to apply toward their choice of plan, selected from a menu of private prescription-drug coverage options. If they prefer a more expensive plan, they can make up the difference themselves. Because this premium-support program is the only source of prescription-drug funding in Medicare, it is able to bring real market forces to bear.

The program also contains a further cost-control mechanism that has come to be known as the "donut hole," by which recipients are required to pay for all drug costs above a certain minimum level and below a ceiling -- a design intended to simultaneously make seniors sensitive to prices yet shield them from catastrophic costs. In 2009, the donut hole required retirees to pay 100% of prescription-drug costs above $2,700 and below $6,154, in order to discourage unnecessary spending. (Obamacare would eliminate this element of the program as well -- sparing seniors from the donut hole, but thereby also shielding them from market forces that can help restrain costs.)

These two market-based elements have indeed kept costs down for this component of Medicare. While Medicare Part D has provided drug coverage to most Medicare recipients and is very popular with seniors, it has so far come in more than 30% below the original cost expectations of the Congressional Budget Office. In a recent report, the actuary of Medicare projects that Part D's cost over its first decade will likely be more than 40% below those original estimates.

Some market-based reforms, then, can work. The premium-support model of Medicare Part D has been a great success. But its application has been limited, and overall Medicare costs continue to climb.


Could there be a way to apply the lessons of this "premium support" and cost-sharing approach to the broader program? The history of failed reform efforts includes one intriguing twist that suggests there just might be.

In 1997, as a result of the Balanced Budget Act, Congress organized the National Bipartisan Commission on the Future of Medicare, under the leadership of Democratic senator John Breaux and Republican representative Bill Thomas. The commission's final recommendation, supported by members of both parties, was that Medicare should be converted to a "market-based Premium Support model" similar to the one used in the Federal Employees Health Benefits Program.

Under the commission's proposed system, retirees would have been able to choose between private health plans and a traditional government-run fee-for-service plan (a consolidation of Medicare Parts A, B, and C). Thus traditional Medicare would have become one option among many, competing for business. Regardless of what option they chose, beneficiaries would have been expected to pay a premium equal to 12% of per capita health costs, but would have paid no premium at all if they bought a plan that was at least 15% cheaper than the average one. In addition, the commission recommended increasing the Medicare eligibility age from 65 to 67, in harmony with Social Security.

After the commission made its proposal, President Clinton made a counter-proposal, shaped in large part by his Treasury secretary, Lawrence Summers. He proposed "managed competition" for Medicare, in which private insurers would have engaged in competitive bidding for health coverage of the elderly. Retirees who chose plans that cost less than the average bid would have retained three-fourths of the savings. Clinton also proposed new subsidies to encourage employers to retain private-sector health coverage for their retirees, taking some of the burden off of Medicare.

These two sets of proposals were, in many ways, quite compatible. Indeed, according to historian Steven Gillon, President Clinton and House Speaker Newt Gingrich, along with several prominent Senate Democrats, were close in 1997 to a historic agreement for reforming Medicare along these lines. But after the Monica Lewinsky scandal erupted in early 1998, Clinton was focused on defending himself from impeachment, and this required currying the favor of ideological Democrats over pragmatic ones. Thus no serious effort was made to bridge the various reform proposals, and Medicare's problems went unresolved.

Even though it went by the wayside, the basic structure of the Breaux-Thomas commission's proposal -- transforming Medicare into a premium-support system in which retirees have a pre-set benefit they can use toward the purchase of approved private insurance plans -- remains the most plausible approach to addressing Medicare's immense and growing problems. A number of reform proposals offered in the years since the commission's report have followed its lead in general terms, though always with particular tweaks or additions.

The most prominent, and surely the most important, of these is the 2012 budget resolution recently passed (by the Republican majority on a party-line vote) in the House of Representatives. Proposed by House Budget Committee chairman Paul Ryan, the budget included a plan to transform Medicare into a premium-support system beginning in 2022. This would mean that all current retirees, as well as people who will retire by that year, would be left in the existing Medicare system (unless he chooses to, no American now over the age of 55 would be transitioned into the system of premium support); a new structure, however, would be established for new retirees from 2022 onward.

Rather than pay all providers a set fee directly, this approach would let retirees use the money (in the form of a premium-support payment that would start at current Medicare rates and grow with overall inflation) to choose insurance plans from a menu of private coverage options. To participate, private insurers would have to agree to accept all Medicare recipients, to charge the same premiums to all beneficiaries of the same age, and to provide at least a minimum benefits package required by the Office of Personnel Management (which runs the Federal Employee Health Benefit Plan), with the idea of providing all seniors with guaranteed affordable comprehensive coverage.

The level of premium support would increase with age, and poor seniors and those in the worst health would also get significantly greater support, while the wealthiest would receive less and so need to use more of their own money to buy coverage. And the premium-support model would not be a small experiment overshadowed by traditional Medicare (and thus unable to really change the way insurers and providers do business): It would be the core of the new Medicare system, and the means by which seniors would be guaranteed coverage.

This approach, then, would work like the Medicare prescription-drug benefit (and like the health-insurance program made available to federal employees). Insurers and providers would need to compete for seniors' dollars, and to do so they would be free to find innovative ways to offer better quality at lower costs. That's how markets produce efficiency: by letting sellers find ways to offer buyers what they want at prices they are willing to pay.

Although the precise effect of this approach on overall health-care costs is difficult to predict, there is no question that such a reform would dramatically improve Medicare's fiscal prospects and reduce the burdens it would place on the broader federal budget.

All you really need to know about the difficulty of making Third Way reforms is that Bill Clinton had to punt to curry favor with the Left and the Right despised W for his success on Part D. The two extremes conspire to prevent the sensible middle way.

Posted by at August 23, 2011 9:18 AM

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