I published a paper in 2005 with Steve Pizer and Roger Feldman on the curious and costly way regional PPOs were encouraged to enter the Medicare private plan market. The paper, "Defective Design: Regional Competition in Medicare" (Health Affairs, 2005) includes a nice summary of why the PPO, so popular in the commercial market, is less so under Medicare While at least half of commercial plan enrollment is in PPOs, local and regional Medicare PPOs attract, respectively, only 8% and 3% of enrollment in all Medicare Advantage plans.
PPOs represent a less restrictive alternative to HMOs for both enrollees and employers. They typically do not attempt to manage care, instead reducing costs by organizing networks of credentialed providers who offer discounted rates. Despite some efforts by the Medicare to involve PPOs (principally through a demonstration), enrollment to date has been small.
One intent of the 2003 Medicare Modernization Act (MMA) was to improve beneficiaries’ access to private plans offering comprehensive benefits by requiring that PPOs enter markets regionally in 2006. Twenty-six multi-state PPO regions were established, each designed to combine traditionally underserved areas with urban markets typically served by HMOs. Regional plans are constrained to offer uniform benefits and charge the same premium within each region they enter.
Because Medicare HMOs can still be offered on a county-by-county basis while PPOs must be offered regionally there is a competitive imbalance between the two plan types. HMOs are free to cherry pick the most profitable counties while PPOs cannot do so.
In addition to this competitive imbalance, there are two other reasons why the PPO model is not adaptable to the Medicare market. First, PPOs typically pay providers more than the payment rates set by fee-for-service (FFS) Medicare, which has tremendous market power. Consequently, PPOs will have to charge a typical beneficiary a higher premium for the same benefits available through traditional Medicare, with provider-choice restrictions
not found in traditional Medicare. Second, PPOs’ commercial success is partly attributable to their popularity with self-insured employers who want help administering their plans; FFS Medicare needs no such help.
The upshot of all this is that PPOs don’t work well in Medicare. They have trouble competing on price and benefits where HMOs exist (the more urban counties) and they have trouble competing with traditional Medicare elsewhere due to their network restrictions. This is an interesting example of how a plan type that works in the commercial market fails to thrive in a different setting, one in which the rules of the game are different.
It was not broadly obvious that this was the likely fate of PPOs under Medicare. Though, my colleagues and I did predict it in our 2005 paper, published before regional PPOs were available. We did so using established econometric models of Medicare plan entry and payments. This was a triumph of economic prediction. The fact that prediction matched reality so well is affirming evidence of the value of this type of work. (Next step: getting policymakers to actually notice what we do.)