Why try competitive bidding?

Some are skeptical that private health insurance plans could deliver the Medicare benefit at lower cost than can traditional Medicare. Others are skeptical that traditional Medicare could ever be cheaper. It’s good to be skeptical. But skepticism is not the same as evidence. In fact, we have no evidence from a fair head-to-head test of private plans vs. traditional Medicare.

You might be thinking, “Wait! What about Medicare Advantage? Doesn’t that program show that it costs more to deliver benefits privately than through a public program? Haven’t you, Austin, even said just that?”

I have written considerable about the relative costs of MA vs. traditional Medicare. But I have never said it was a fair head-to-head test of the two approaches. Congress has never allowed such a test. If it did, we might finally know which approach is cheaper.

Or, you could be thinking, “Wait! What about Part D. Plans compete and premiums and program costs are below original predictions.”

Yes, Part D does have a competitive bidding design. But, there is no public option. It’s not a test of private vs. public.

If we do force private plans to compete against traditional Medicare in a fair, head-to-head test, the results are likely to be mixed. What we are likely to find is that traditional Medicare is cheaper in rural areas, due to the high costs of establishing provider networks in such areas. Provider market power in rural areas mean private insurers would have to pay high prices, costing the government and/or beneficiaries more. Traditional Medicare, being immune from market forces (though not political forces) can counter that provider market power, essentially setting “below market” prices by fiat. (Don’t go thinking this is an affront to a perfectly competitive market. High provider market power is itself a deviation from a perfect market.)

The flip side is that private insurers (or some of them) might actually be cheaper in urban markets in which there is enough provider competition. Though politics essentially compels traditional Medicare to pay providers enough so that nearly all will participate, private insurers need not do so. They can establish networks, excluding higher cost providers. The benefit of selective contracting is lower prices.

There are other reasons for cost differences between private plans and traditional Medicare: private plans might enjoy (or arrange) favorable selection, enrolling healthier than average individuals. Private plans might have a greater incentive for and more generously fund fraud control. On the other hand, traditional Medicare might have lower administrative costs. (All of this is not without controversy. Notice that I wrote “might” in each sentence. I’m not taking sides or citing evidence so I’m not making any claims here.)

Nevertheless, if all of this can be “evened out” so a truly level playing field is arranged,* one that forces private plans and traditional Medicare to compete, we might then know which is actually cheaper and where. In the absence of such a test, we just have competing claims based on (informed) hunches and extrapolation. We can do better.

Since the political equilibrium seems to be a Medicare that includes both public and private options, why continue to overpay for one, the other or both? That brings me to competitive bidding (again). It’s not an idea that necessarily, deterministically, and predictably leads to more or less private or public involvement in the program. It’s an idea that is designed to determine where each model does best and to reward efficiency. The current arrangement, all Medicare proposals associated with Rep. Ryan, as well as many other “premium support,” “defined contribution,” or “voucherization” schemes have a fundamental flaw that prevents us from really knowing which model is superior and where. Coulam, Feldman, and Dowd explain,

[U]nder the current system, information about the costs of care flows in the wrong direction–from an organization that knows very little about the costs of providing insurance (the federal government) to the organizations that know as much as possible about these costs (private MA plans). This virtually guarantees misallocation of resources.

Competitive pricing reverses the flow of information. Through a bidding process, MA plans would tell the government how much it costs to care for Medicare beneficiaries. The reward or penalty for bidding low or high would be predictable–beneficiary out-of-pocket premiums–thereby providing an incentive for plans to offer their best price. For competitive pricing to work, it must encompass all Medicare health plans, including the FFS Medicare plan. […]

In a competitive pricing system, plans would submit bids on the defined benefit for a beneficiary of average risk (a “standardized beneficiary,” adjusting for differences in age, health status, and other characteristics that affect the use of services). MA plans do this now. The FFS “bid” would be based on average FFS costs for the same type of standardized beneficiary in the bidding area. The government would use those bids to determine the benchmark payment rate (the government’s contribution to premiums) for all Medicare plans, including FFS Medicare. Currently, MA bids are not used to set the benchmark.

This is the key. If bids are not used to set the “benchmark,” which is essentially the same as the “voucher,” “subsidy,” level of “premium support,” or “defined contribution,” then they are set in a way divorced from actual plan costs. That is, they’re set by some administrative process that is subject to political manipulation. This is precisely the reason MA payments are well above FFS costs. We should expect the same fate of any other proposal that does not harness an apolitical process. Coulam, Feldman, and Dowd continue,

The reward for low bidders would be increased enrollment. The penalty for high bidders would be lower enrollment as a result of having to charge an additional premium, making them less attractive to beneficiaries than less expensive plans that meet the same quality standards. […]

There are serious problems with an MA-only bidding arrangement. The inefficiency from excluding the FFS Medicare plan is large. In areas where the FFS Medicare plan is more expensive than private MA plans, beneficiaries who prefer the FFS Medicare plan face no consequences even though their choice costs the Medicare program more money. The reverse is also true: in areas where the FFS Medicare plan is cheaper, beneficiaries who prefer private MA plans will not have to pay the extra cost that their preference imposes on the Medicare program, unless MA payments are capped at FFS Medicare spending levels.

Coulam, Feldman, and Dowd also wrote a book on competitive bidding. I’ve read it. I will find some time to flip through it again to see if there are some revealing charts that might help readers better understand the idea and related concepts. Meanwhile, I urge you to check your preconceptions at the door. If you’re so certain that traditional Medicare is cheaper or private plans are, then you should not be afraid to put them to a fair, head-to-head test. Where skepticism is warranted is whether such a test will ever come about.

* It’s no simple matter to arrange a “level playing field.” Even if doing so is next to impossible, there is value in thinking about the possibility of a fair, head-to-head test of private vs. public plans. Just thinking it through as a thought experiment helps reveal where each model might have something to contribute and how our own bias contributes to preventing us from admitting so. It also illuminates the key problems with other voucherization ideas.

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