• “Payment Reduction and Medicare Private Fee-for-Service Plans,” Frakt, Pizer, Feldman (2009)

    This is the first of an occasional series of posts that summarize my academic journal articles. This post has been cited in the 20 August 2009 Health Wonk Review, hosted by Health Business Blog.

    My most recent publication is the 2009 Health Care Financing Review article Payment Reduction and Medicare Private Fee-for-Service Plans by Frakt, Pizer, and Feldman. Below is the abstract followed by an explanation of the contributions the work.

    Medicare private fee-for-service (PFFS) plans are paid like other Medicare Advantage (MA) plans but are exempt from many MA requirements. Recently, Congress set average payments well above the costs of traditional fee-for-service (FFS) Medicare, inducing dramatic increases in PFFS plan enrollment. This has significant implications for Medicare’s budget, provoking calls for policy change. We predict the effect of proposals to cut PFFS payments on PFFS plan participation and enrollment. We find that small reductions in payment rates would reduce PFFS participation and enrollment; if Congress reduces payments to traditional FFS levels it would cause the vast majority (85 percent) of PFFS plans to exit the market.

    As is clear from the abstract the paper is about PFFS plans, which are a particular type of MA plan. In brief, MA plans are private Medicare plans (mostly HMOs) that receive payment from the government to provide benefits to Medicare beneficiaries. PFFS plans are a type of MA plan but they are not like HMOs: they do not have to set up provider networks and they pay providers on a fee-for-service basis using the traditional Medicare fee schedule.

    PFFS plans are the closest thing to direct privatization of traditional Medicare. To a good approximation you can think of them as private organizations that get paid to do what the government already does. For more background reading on MA and PFFS plans see my prior post Medicare’s Structure and Payment Systems, Part II: Medicare Advantage.

    The article makes two main contributions. The first is a 2001-2009 time series of Medicare payments to MA and PFFS plans relative to the average cost of a beneficiary enrolled in traditional FFS Medicare. To the authors’ knowledge such a time series had not yet been provided elsewhere (it is a non-trivial exercise to compute this time series in a consistent manner).

    The time series is shown below (click to enlarge). It reveals that, relative to FFS costs, payments to MA (thin solid line) and PFFS plans (dashed line) have been above one in all years and particularly high since 2004. Subsequent to the increase in payments since beginning in 2004, enrollment in PFFS plans increased dramatically (thick solid line). (There is a technical detail pertaining to a change in payment methodology beginning in 2006. That’s why the term “benchmark” (or “B’mark”) is used in the figure. Roughly speaking you can interpret this as the payment to plans. More accurately it is the maximum possible payment.)


    To make it explicit, that MA or PFFS payment relative to FFS costs is above one means that it costs Medicare (and taxpayers) more to cover the care of a beneficiary enrolled in an MA plan than in traditional FFS. The extra payment to MA plans is supposed to be used to provide coverage more generous than that available under FFS Medicare and at least some of it does since MA benefits are richer and cost sharing lower than FFS Medicare.

    But why are are taxpayers paying private plans more to do a job that has traditionally been done by the federal government for lower cost? Of course the answer is “politics.” There has been an effort to expand the role of private plans in Medicare, in particular attracting them to rural areas with payment rates higher in proportion to FFS costs relative to non-rural areas. In rural areas provider networks are costly or impossible to set up due to the lower density of providers. Since PFFS plans are not required to establish provider networks they have disproportionately thrived in rural areas (relative to other MA plans). Hence, PFFS plans are the costliest plan type, relative to FFS. This is widely known and the article makes the point again with a 2001-2009 time series.

    The second main contribution of the paper is to illustrate with a simulation what might happen if payments to private plans are cut, as has been proposed by MedPAC, CBO, and others. After estimating a model of PFFS participation in Medicare using public data, my co-authors and I simulated the effect of implementing payment parity (payments at 100% of FFS cost). We find that such a policy would nearly wipe out PFFS plans, reducing their participation by 85%.

    This degree of payment reduction appears to be the direction the Administration and Congress want to go. Of course they won’t just cut payments to PFFS plans but to all of MA. Many beneficiaries will lose the generous coverage they currently enjoy under the program, but taxpayer dollars will be saved (or, rather, redirected into health reform).

    • What about provider cost shifting? You can either pay higher premium rates through MA, like the article says, or you can pay higher premium rates for you own premiums (probably both) because providers are going to have to charge more to private insurance to make up the difference. I suspect that there would be beneficial market consequences if Medicare and Medicaid reimbursed at a level that covered their own costs in the first place.

      • @John – Thanks for your comment. It raises some interesting issues that are worth thinking about.

        The provider cost shifting argument is one often made in the context of proposals to reduce provider payments from a subset of insurers. In this instance there is a twist that makes that argument less applicable. PFFS plans typically don’t negotiate provider rates and simply pay providers the FFS Medicare rates. If PFFS plans are paid less (or exit the market) that won’t affect provider rates. More generally, MA plans pay providers at or below FFS Medicare rates. To the extent that the MA program shrinks in terms of number of enrollees due to lower payments, that’s good for providers.

        What about the marginal case where an MA plan doesn’t exit the market but some of its competitors do. It is possible that in this case it has the additional market power to extract greater concessions from providers in the form of lower fees. If providers can really shift costs to other insurers (that they can do this is not a foregone conclusion–it is debatable), then you’re point has some merit. But I think this is a second- or third-order effect. The primary effect of reduced MA payments is lower health spending because those extra MA payments are going toward increased insurer profits and extra benefits that beneficiaries would not otherwise have. If those profits and/or those extra benefits (and the extra utilization they induce) go away that’s a savings. (Some of the utilization induced by those extra benefits will occur anyway, but far less.)

        One cannot simply wave the “cost shifting” flag in all instances of payment reductions. And, as I said, it is possible there is little or no real cost shifting possible. For the economics argument on this point, see the 2001 Health Affairs paper by Richard Frank “Prescription Drug Prices: Why Do Some Pay More Than Others Do?

    • I have to add that these plans might not offer state of the art MRI imaging for instance. So patients WOULD NOT BE ABLE to choose a 3T MRI which is more detailed and faster (and costs more to produce) but we offer it actually at lower prices. We offer a state of the art 3T MRI and soon … a 32 channel 3T MRI which is even more detailed for only 500 a person out of pocket price. No one else does that in the world!

      a 32 channel 3T system costs about 3 million dollars installed. A similar 1.5T is half the price.