Tomorrow’s Medicare: The efficient hybrid?

The following is the text of my 9 September 2010 Kaiser Health News column.

Since the inception of Medicare, policymakers have wrestled with the problem of how the program can best pay for beneficiaries’ medical services. The result of this decades-long struggle has been increasing costs and a Byzantine set of payment methods. However, today’s Medicare includes the elements of a more efficient payment system. Ironically, that efficient system would be based on one of the program’s most complex and controversial features: its public-private duality.

Today’s Medicare includes a fee-for-service plan for which the government sets the payment for each service and any willing provider may participate. It also includes private Medicare Advantage plans for which the government sets a capitated (per member) payment. In turn, Advantage plans negotiate provider payments and establish restricted networks. The two arms of this public-private hybrid exist in seeming political equilibrium and have their own specific strengths and weaknesses.

The fee-for-service arm, for instance, is available everywhere and provides a uniform, standard set of benefits. Because it is immune from the effects of provider market power, it is able to establish low prices in some markets, though it has poor control over volume. It also is slow to innovate and to adopt new modes of treatment, as evidenced by the fact that a prescription drug benefit was added to the program decades after such benefits were the norm in commercial insurance.

Meanwhile, private Advantage plans are more nimble. They can adapt as permitted by regulation to beneficiary demand and offer benefits beyond those of fee-for-service Medicare. Advantage plans also selectively contract with providers and are able to obtain low prices for health services in some urban areas where the threat of network exclusion is credible. However, the per-beneficiary taxpayer cost of providing coverage through an Advantage plan exceeds that of fee-for-service Medicare by 13% on average.

It begs the question: which is better — a government-run fee-for-service program or a system based on private plans? Reasonable people can disagree. But when it comes to taxpayer costs, the answer may be, “both.” Counter-intuitively, the program’s messy duality may include the potential for savings and efficiency.

Because health care markets are not all alike, what is best for one market may not be best for another. Within a model of competition across all Medicare plan types, the co-existence of private plans and a public fee-for-service option can be harnessed to reduce program costs.

According to analysis by American Enterprise Institute-funded health economists and researchers taxpayers could save 8% or about $50 billion per year (based on a 2010 Medicare cost estimate) through a competitive pricing system in which all plans, fee-for-service included, offer bids for a standardized set of benefits and the government pays all plans based on the lowest of these cost estimates. These potential savings come from the fact that Advantage plans can achieve lower costs in some markets, while fee-for-service can in others. As a result, with payments pegged to whatever plan type has the lowest cost in each local market, taxpayer dollars are used in the most efficient manner.

Under the bidding model preferred by these AEI analysts the lowest bid in a market – whether from a private plan or from fee-for-service Medicare – would be used to establish the government’s base payment to plans. This amount would then be risk-adjusted according to beneficiary health status. Beneficiaries opting for plans with higher costs or additional benefits would pay the additional cost. Means testing or a low-income subsidy program, as exists in today’s Medicare, could be incorporated to protect poorer beneficiaries from high residual out-of-pocket costs.

Competitive bidding can save money, but it is not a panacea for all of Medicare’s ills, and it doesn’t address every issue associated with the program. It cannot tell us what the standard, required set of benefits upon which plans bid ought to be — only that we need consensus on such a benefit. It would mean that the beneficiary cost of fee-for-service coverage, as well as private plan coverage, would vary across markets, a feature some might consider inequitable. It also cannot, by itself, change the growth rate of health care costs. For that, further reforms to how fee-for-service and Advantage plans pay for care would be required, as well as changes system-wide, well beyond Medicare. However, bidding would ensure that taxpayers get the best value per dollar within the framework of the program’s hybrid public and private structure.

Given the seeming political equilibrium that has given rise to Medicare’s hybrid structure, most or all of tomorrow’s beneficiaries will likely be able to choose between public and private options. A shift to competitive bidding can help deliver those benefits more efficiently.

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