What happens to losing bids under competitive bidding?

A reader wrote me with the following question pertaining to competitive bidding.

If an insurance company that could provide medicare for say $500 a month per beneficiary puts in a bid at $600 a month (assuming that wouldn’t be considered fraud) it would seem that two things could happen: Six hundred is the lowest bid and the company gets $600 instead of $500 a month.  Five hundred is the lowest bid and the company has to adjust its pricing and/or marketing strategy to compete with the company that  bid $500, something that would seem fairly easy to do if it really could do the job for $500.  What is the downside of ” losing” the  bid?

I’ll answer based on my understanding of current Medicare, extrapolating to a competitive bidding regime. Medicare Advantage plans bid today and are paid a subsidy (voucher, premium support), only that subsidy rate is not one number per market that is the same for all plans and based on a function of the bids (hence, that’s why it is not competitive bidding). Nevertheless, with that exception and the fact that traditional Medicare does not bid at all, all of the mechanics are in place for competitive bidding. That’s what informs my answer below. Keep in mind, it’s always possible for Congress to change the rules.

It would be considered fraud (or illegal) for a plan to bid above its actuarial cost for providing the Medicare benefit to an average risk beneficiary. The bids are audited and plans have to demonstrate they are reasonable and accurate. CMS can reject bids. Bids are not available to researchers, but if they were, that would be another check on the market. Believe me, economists would be very quick to find market anomalies and problems. Maybe those bids should be public! (They are bids for taxpayer money, after all.)

Suppose a plan somehow gets away with a bid above cost. It’s still not on easy street. If it could have provided the benefit for $500/month, which, let’s say, happens to be the lowest bid, from a competitor, but it bid $600, it would still only receive a $500 subsidy. It would be forced to charge a $100 premium. It must charge this premium! There is no wiggle room. Note that it would not be able to use that $100 for extra benefits without tipping off the auditors. So, the plan would be very costly for what it provides. Beneficiaries would have to pay $100 out of pocket for the same benefit they could have obtained for $0 from a competing plan. Beneficiaries aren’t going to like that. I don’t think this plan would survive.

If all plans got away with this game — fooling the auditors — and overbid, then the lowest bid would be an overly generous subsidy. But that can’t happen in a suitably competitive environment. Every plan has an incentive to bid as low as possible, to force competitors to charge a premium (recall from the prior paragraph that they must do so if they are above the winning bid). So, if all plans are overbidding, it would suggest insufficient competition or collusion. Call in the trust busters!

Since traditional Medicare is (or should be) one of the bidders and it isn’t going to commit fraud (not purposefully and malevolently anyway), that’s another backstop and a source of competition. All in all, if appropriate oversight is in place and there are at least a few plans competing, I’m not convinced there is cause for concern about plans bidding more than their true costs.

Note that if this were a valid concern, it would also apply to the ACA exchanges, Medicare Part D, and the FEHBP, among other government procurement programs that use competitive bidding. For some reason, when we talk about comprehensive Medicare plans, people get bothered by things that don’t seem to arise as issues in other contexts.

Related: See my post that attempts to explain competitive bidding in the simplest possible terms.

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