Medicare Advantage is not efficient, but here’s how it can be

The following originally appeared on The Upshot (copyright 2014, The New York Times Company).

Medicare Advantage plans — private plans that serve as alternatives to the traditional, public program — have been growing in popularity. One reason is that they offer additional benefits beyond those available in the traditional program but often at no additional cost to beneficiaries.

This is a great deal for beneficiaries, but a bad one for taxpayers, who have to cover the extra cost. If the program were reorganized to more closely resemble the Affordable Care Act’s exchanges, it could still provide good value to consumers at a lower cost to taxpayers.

The standard explanation for how Medicare Advantage plans are able to offer more has two parts, both problematic.

1) Private plans are more efficient than the public program; they can buy more care for fewer dollars and can manage care so patients use health services with less waste. This leaves more headroom to fund extra benefits.

2) Per person covered, plans are paid well above the average cost of providing the Medicare benefit; they can turn this payment surplus into additional benefits.

On the first point, the assertion that Medicare Advantage plans are, on average, more efficient than traditional Medicare has little support. According to the Medicare Payment Advisory Commission, which advises Congress on Medicare payment policy, in 2014 Medicare Advantage plans could provide the same benefits for 2 percent less than the cost of traditional Medicare.

But this analysis does not account for the fact that Medicare Advantage enrollees are at least a little bit healthier than traditional Medicare enrollees, as many studies have shown. Thus at least some of the difference in cost is due to the type of individuals drawn to Medicare Advantage, not to greater efficiency of private plans. When this is factored in, it’s unlikely that Medicare Advantage has an efficiency advantage over traditional Medicare, on average.

The second claim is true, up to a point: Medicare Advantage plans do turn some of the higher payments they receive into extra benefits.

But at least three studies suggest that for each dollar of these higher payments that plans receive, beneficiaries get only a fraction of a dollar of value. A study by Harvard scholars found that a $1 increase in payment translates to at most 50 cents in additional benefits. Another by researchers from the University of Pennsylvania found that only 20 cents of each additional dollar in plan payment is converted into better coverage. Finally,my own work with my colleagues Steven Pizer of Northeastern University and Roger Feldman of the University of Minnesota found that only 14 cents per dollar of additional payment benefits Medicare Advantage enrollees.

Whether it’s 14, 20 or 50 cents on the dollar, Medicare beneficiaries are not getting the full value of taxpayers’ largess. Sure, something is better than nothing, which is why many beneficiaries passionately defend the Medicare Advantage program. But could that deal be improved?

One way is to make Medicare Advantage plans (and traditional Medicare as well) compete more vigorously for enrollees. Today, plans receive a government subsidy according to an administratively set formula that does a poor job of matching payments to actual costs.

An alternative based on the Affordable Care Act’s structure could work something like this: Plans would submit bids for covering the Medicare benefit, as they do today. Then, instead of basically paying them what they bid in addition to some extra (which is more or less what happens today), the government would pick one of the cheaper bids (for example, the second lowest) and just pay that to all plans. [See analysis of such a plan by Roger Feldman, Robert Coulam, and Bryan Dowd.]

This is similar to how the Affordable Care Act, which bases subsidies on the cost of the second-cheapest silver plan, and the Medicare Part D prescription-drug plans work. Someone who wants a plan that costs more than the government payment must pay more out of pocket. Extra subsidies would be provided for low-income consumers, same as in the Affordable Care Act and Part D.

With such a structure in place, plans would compete more vigorously. Being the second-cheapest or cheapest plan would be a huge advantage. Other plans would have to charge a premium. Plans would not offer extra stuff beneficiaries might not value highly.

That’s a far cry from today’s Medicare Advantage, in which extra benefits are worth far less to beneficiaries than what taxpayers pay for them. It’s an inefficiency we know how to correct, but, to date, we’ve been unwilling to.

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