Decomposing Medicare

Ezra Klein and Tyler Cowen have both posted today on ways to think about Medicare reform. I think both dance around an idea without explicitly stating it: Medicare, or any health insurance scheme, can be thought of a combination of a set of benefits and a payment system.

Different existing and proposed ways of delivering Medicare do different things in these two domains. Traditional (FFS) Medicare has a defined benefit. That’s one feature that many point to as the essential nature of the program. As a beneficiary, you know what you’re going to get. Medicare Advantage shares this defined benefit as a required minimum, but MA plans can offer more than that. Part D has a separate minimum, defined benefit, pertaining just to prescription drugs.

However, MA and FFS Medicare differ in the nature of their payment systems and the extent to which they are subject to market forces. The former is more market based than the latter, which means that MA payments to providers are set by negotiation. As you would expect, where providers have higher market power relative to insurers, MA payments to them are higher. In rural areas where hospital market power is maximum, only MA plans that don’t rely on establishing provider networks (i.e., that don’t even negotiate with providers) exist, the so-called private fee for service (PFFS) plans.

PFFS plans also piggy-back on the FFS fee schedule. In other words, they are private but not subject to the full set of market forces like other MA plans. Put another way, it is the structure of traditional Medicare  — the fact that it is not subject to market forces — that can withstand the market power of hospitals in rural areas. Insurers don’t bother to offer MA HMOs there because the premiums they would have to charge would be so high too few beneficiaries would enroll.

But that’s all variation on the payment side of the system. All these plans offer at least the minimum benefit.

Now take the Ryan-Rivlin plan, which may or may not resemble what Rep. Ryan will propose later this week. That approach is MA-like only in the sense that it would rely on private plans. It would not guarantee a minimum, defined benefit.

What would happen to private plans offered under a Ryan-Rivlin-like system in rural areas? Likely they would have very high premiums for relatively low benefit levels. Meanwhile, beneficiaries in urban areas would, perhaps, see something like the MA plans they have today (before voucher levels eroded, though it is questionable they would).

Issues of geographic equity would naturally arise. Perhaps they could be solved by making voucher levels vary by region, as they do in MA today. Still, in MA today, payment rates for rural areas, though they are above FFS costs, are not enough to attract as many plans as exist in urban areas. Already this is starting to sound exactly like the debates that have arisen with respect to MA. How much above Medicare FFS costs are we willing to pay private plans to participate in rural areas?

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