Medicare’s Structure and Payment Systems Part II: Medicare Advantage

This post originally appeared on The Finance Buff.

This post is the second in a three part series on Medicare’s structure and payment systems. The first post is found here. I expect the final post to be released next week (link to final post).

In my first post on Medicare I summarized some of the elements of fee-for-service (FFS) Medicare. Beginning in the early 1970s and growing in fits and starts since then, Medicare has included other types of insurance plans offered through private carriers. This post will review some of these other Medicare products.

Medicare Advantage

The Medicare Advantage (MA) program (a.k.a., Medicare Part C) shifts the cost risk from the Medicare program to a private insurance company. For the moment think of an MA plan as an HMO or a PPO. Through an MA plan, beneficiaries receive the hospital (Part A) and outpatient (Part B) insurance they would otherwise get directly from FFS Medicare. Many MA plans offered a drug benefit before such benefits became available to all beneficiaries in 2006 (via Part D).

Medicare pays an MA plan a predetermined monthly rate for each beneficiary it covers, independent of the services used (the rate is adjusted to reflect the financial risk of the beneficiary to the plan). The plan may also charge enrollees a premium and other cost sharing. An MA plan may offer benefits more generous than FFS Medicare, covering more services at lower cost to the beneficiary. About 20% of Medicare beneficiaries are enrolled in an MA plan, and the program accounts for nearly the same proportion of Medicare spending.

Thus, an MA plan acts as a middleman between Medicare (the taxpayer) and the service provider (the doctor or hospital). The plans, not Congress, negotiate payments with service providers and are at risk for the cost of covering each enrolled beneficiary. Since MA plans are private entities bearing risk, negotiating with providers, and competing for beneficiaries the MA program has the patina of a “free market” solution to cost control.

But Congress sets the payment rates. The payment system uses terminology that sounds like competitive bidding. Plans “bid” against a “benchmark,” which is the payment rate cap (the most paid for an average-risk beneficiary). If the bid is below the benchmark, the plan receives 75% of the difference to fund additional benefits and/or lower cost sharing.

However, the benchmark has nothing to do with plan costs. It is set by Congress via a complex formula. Today, on average payments to MA plans are 14% higher than average FFS Medicare payments. This is not because MA plan enrollees are 14% more costly. In fact, evidence suggests that MA enrollees are, if anything, less costly than FFS beneficiaries. Besides, the payments are risk adjusted. No, MA plans are simply overpaid.

The History and Future of MA Payment Rates

Plans weren’t always overpaid. Prior to 1997, for each enrollee, Medicare HMOs were paid 95% of per beneficiary FFS cost. The logic was that private plans ought to be able to provide Medicare services more efficiently than FFS Medicare through a combination of controlling utilization and driving hard bargains with providers. So, Medicare took 5% off the top. Competition was supposed to ensure quality and the provision of services of value to beneficiaries. A consequence, however, was that insurers didn’t offer plans in rural areas where contracting and marketing were too costly relative to the payment.

To increase the role and availability of Medicare HMOs, payments were increased over the years and are now above FFS costs. In addition, a new plan type was introduced, Private Fee-for-Service (PFFS). These plans are exempt from many of the requirements other MA plans face but are paid just as generously. In particular they do not have to set up provider networks and can base their costs on the FFS physician payment schedule. They’re indemnity insurance just like traditional FFS Medicare, only offered through private insurers. In recent years PFFS plans have been the fastest growing and most costly MA plan type.

There have been numerous calls by Medicare and budget watchdog groups to reduce MA plan payments to 100% of FFS cost (the Medicare Payment Advisory Commission, the Congressional Budget Office). Another option likely to reduce payments would be to abandon the administrative pricing scheme altogether and shift to a competitive bidding model. Plans with lower bids for standard benefits would win contracts while higher bid plans would not. Or, in another variation, plans with bids above the average would simply charge the difference as premium, while those below the average might be able to offer a rebate or extra benefits with the difference.

President Obama’s budget proposal includes a plan for MA competitive bidding. I will be watching closely to see if Congress retains this idea as next year’s budget works its way through the legislative process.

In my next post on the basics of Medicare I will discuss the relatively new prescription drug program. It already has competitive bidding (for real). But it has other features which cause it to be more costly than it could be.

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