Medicare’s private plans

This is a TIE-U post associated with Jonathan Oberlander’s Political Dynamics and Policy Dilemmas (UNC’s HPM 757, Fall 2011). For other posts in this series, see the course intro.

This week’s reading included two papers describing Medicare’s two parts that offer benefits through private plans, Part C (comprehensive health plans, Medicare Advantage) and Part D (prescription drugs). Neuman and Cubanski (2009) covered issues pertaining to the prescription drug benefit and McBride (2008)  addressed the history and performance of Medicare Advantage. McBride’s paper is an excellent reference on MA payment policy and consequences.

I’ve written many words on this blog and in my research publications on both MA and Part D. In fact, I’m still at it. What follows is excerpted from a draft of something I’m working on.

Medicare Advantage

Medicare Advantage (MA)  plans are qualifying private health insurance plans that offer Medicare Parts A (hospital insurance), B (physician and outpatient coverage) and, optionally, D (outpatient prescription drug coverage). Since they are driven by rules established by Congress and play a large role in the cost of MA to taxpayers, much of the politics of Medicare hinges on MA payment rates. Before 1997, plans were paid 95% of their estimated costs. Since then, plan payments have been only indirectly related to costs, and, in recent years, plans have been paid far above what it would cost to cover a beneficiary in FFS Medicare (Frakt, Pizer, Feldman 2009a).

By law, plans must use a portion of the amount by which they are paid above their estimated costs to provide additional benefits, reduced cost sharing, or lower premiums. However, the associated consumer surplus, the value to beneficiaries of the additional generosity provided, is relatively low. In 2006, the value to beneficiaries of each taxpayer dollar spent on additional benefits above those provided in 2003 was about 14 cents (Pizer, Frakt, Feldman 2009b).

Though there are many types of MA plans, the two principal variants are coordinated care plans (CCPs), mostly HMOs and PPOs, and private fee for service (PFFS) plans. The principal difference as far as market competition is concerned is that PFFS plans do not establish provider networks and CCP plans do. At each visit, a physician may accept or decline to see a PFFS patient. CCPs, in contrast, enter into contracts with providers, which affords a degree of bargaining power. To the extent they can exclude providers from networks, they have leverage to negotiate lower prices.

In fact, some CCPs have been able to negotiate prices below those of FFS Medicare in more urban areas where providers are more densely present. In other areas, CCPs pay higher rates than FFS Medicare. Plans don’t participate equally in all areas for these reasons (Pizer, Feldman, Frakt 2005, Pizer, Frakt, Feldman 2008).

MA plans compete with each other on price (premium and cost sharing) and benefits. The effects of competition  are comparable in importance to those of payment rates. Increasing competition, like increasing payment rates, lowers premiums and raises generosity of benefits. (Pizer, Frakt 2002). Higher concentration is associated with higher generic and brand copays and lower drug caps (Pizer, Frakt, Feldman 2003).

Plans also compete with the (fixed) FFS benefit for enrollees, though rates of enrollment in MA vs. FFS tracks generosity of government subsidies. This raises the question, what would be an appropriate, market-based payment rate provided to MA plans? One way to address that question would be for plans, both MA plans and FFS Medicare, to compete for the subsidy rate, essentially submitting bids in a type of auction. Such a “competitive bidding” or “competitive pricing” concept has been studied by economists and policy analysts. According to one estimate by Coulam, Feldman, and Dowd (2009) such a system could reduce Medicare program spending by 8% by setting the government payment rate at the lowest submitted bid. Beneficiaries wishing to enroll in costlier plans (e.g., those that provided additional benefits or just had a higher cost structure) would have to pay more out of pocket.

Part D

Medicare Part D is the most recent major expansion of Medicare (implemented in 2006), offering voluntary, universal access to subsidized prescription drug coverage through private plans. MA plans can offer drug benefits (those that do are termed MA-PD plans), and for beneficiaries not enrolled in a CCP, there are stand-alone prescription drug plan (PDP) options. In fact, there are a lot of them, about 30 available to every beneficiary. One of the concerns about Part D is that, with so many options, beneficiaries have a hard time making the best choice (Abaluck and Gruber 2011).

The large number of plans suggests there is a vigorous level of competition among Part D plans. One finding consistent with that notion is that beneficiaries are relatively price sensitive in the PDP market, more so than for MA plans. Frakt and Pizer (2010) estimated the premium elasticity of demand to be -1.45, meaning a 10% increase in a plan’s premium would lead to a reduction in enrollment of 14.5%.

The Part D market differs from the MA one in its competitive design. In contrast to the administered pricing system of MA, all Part D offering plans (PDPs and MA-PDs) participate in a competitive bidding (auction) process that sets the rate at which they are subsidized by the government. About 75% of the national average bid establishes the subsidy rate and beneficiaries pay more in an out of pocket premium for costlier plans. They pay a lower premium for cheaper ones.

One of the controversies that arose in debate over Part D legislation was how the prices paid by plans would be set. Some wanted prices set program-wide, using a government fee schedule available to other government health programs like Medicaid and the Veterans Health Administration (VA). Others thought private plans should negotiate with drug manufacturers in the market place. Proponents of a market-based approach won, but the legislation included some constraints on the degree to which plans can leverage their negotiating power.

Formulary requirements constrain how vigorously plans can negotiate with manufacturers. Part D plans must include two drugs in every drug class and “all or substantially all” in six designated classes. The requirement to include a minimum number of drugs in all classes and the inability of plans to exclude drugs from six specific classes hampers their ability to extract lower prices from manufacturers (Frakt, Pizer, Hendricks 2008).

In contrast to Part D plans, the VA offers veterans a formulary with substantially fewer drug options, though with no evidence of adverse health effects. Though the average Part D plan covers 85% of the most popular 200 drugs, the VA covers only 59% of them. In part due to its tighter formulary, the VA is able to purchase drugs from manufacturers at prices 40% below those of Part D plans. Frakt, Pizer, and Feldman (2011) estimated that if Part D plans could offer formularies as restrictive as the VA and pay the corresponding VA-like prices, Medicare would save $510 per beneficiary per year. However, the reduced access to drugs would come at a price, measured as a loss of consumer surplus of $405 per beneficiary per year. Notice, however, that the loss in consumer surplus is lower than the savings. So, in principle, beneficiaries could be more than compensated for their loss.


Medicare offers a blend of subsidized private and public coverage, within which plans are paid according to different schemes. Across parts of the program, plans (public and private) compete with each other to varying extent and have different degrees of negotiating leverage with respect to providers and suppliers. The ad hoc and hybrid public-private structure of the program reflects political compromises. Though economic analysis of aspects of Medicare offer considerable insight into the program, to fully understand how it is shaped, how it will evolve, and why requires consideration of more than just economics. The political economy of Medicare is equally relevant to its structure and performance, if not more so (Oberlander 2003).


Abaluck J and Gruber J. Choice Inconsistencies among the Elderly: Evidence from Plan Choice in the Medicare Part D Program. The American Economic Review, Volume 101, Number 4, June 2011 , pp. 1180-1210(31)

Bishop T, Federman A, and Keyhani S. Declines in Physician Acceptance of Medicare and Private Coverage. Arch Intern Med. 2011;171(12):1117-1119.

Chernew M, Sabik L, Chandra A, Gibson T, Newhouse J. “Geographic Correlation Between Large-Firm Commercial Spending and Medicare Spending.” American Journal of Managed Care, 16(2):131-38, 2010.

Coulam R, Feldman R, Dowd B. 2009. Bring Market Prices to Medicare. AEI Press: Washington DC.

Frakt A and Pizer S. 2010. Beneficiary Price Sensitivity in the Medicare Prescription Drug Plan Market. Health Economics 19(1). January.

Frakt A, Pizer S, and Feldman R. 2009. Payment Reduction and Medicare Private Fee for Service. Health Care Financing Review 30(3). Spring.

Frakt A, Pizer S, and Hendricks A. 2008. Controlling Prescription Drug Costs: Regulation and the Role of Interest Groups in Medicare and the Veterans Health Administration.  Journal of Health Politics, Policy and Law 33(6). December.

Frakt A, Pizer S, and Feldman R. 2011. Should Medicare Adopt the Veterans Health Administration Formulary? Health Economics. Published online. April.

Gold M, Jacobson G, Damico A, and Neuman T. Medicare Advantage Enrollment Market Update. Kaiser Family Foundation. September 2011.

MedPAC. Report to the Congress: Medicare Payment Policy, Appendix B. March 2003.

McBride T.  2008.  Medicare Advantage: What Are We Trying to Achieve Anyway?  St. Louis University Journal of Health Law & Policy 405-423.

Morrisey, M. 1994. Cost Shifting in Health Care: Separating Evidence from Rhetoric.Washington, DC: AEI Press.

Oberlander J. 2003. The Political Life of Medicare. The University of Chicago Press.

Neuman P and Cubanski J.  2009.  Medicare Part D Update—Lessons Learned and Unfinished Business.  NEJM361(4): 406-414.

Pizer S, Frakt A, and Feldman R. 2008. Predicting Risk Selection Following Major Changes in Medicare. Health Economics 17(4):453-468. April.

Pizer S, Feldman R, and Frakt A. 2005. Defective design: Regional Competition in Medicare.  Health Affairs Web Exclusive w5-399-411. August.

Pizer S and Frakt A. 2002. Payment Policy and Competition in the Medicare+Choice Program. Health Care Financing Review 24(1):83-94. Fall.

Pizer S, Frakt A, and Feldman R. 2003. Payment Policy and Inefficient Benefits in the Medicare+Choice Program. International Journal of Health Care Finance and Economics 3(2):79-93. June.

Frakt A, Pizer S, and Feldman R. 2009a. Payment Reduction and Medicare Private Fee for Service. Health Care Financing Review 30(3). Spring.

Pizer S, Frakt A, and Feldman R. 2009b. Nothing for Something?  Estimating Cost and Value for Beneficiaries from Recent Medicare Spending Increases on HMO Payments and Drug Benefits. International Journal of Healthcare Finance and Economics 9(1):59-81. March.

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