New Efforts Underway to Inject Competition into Medicare

Published August 1, 2002

In 2001, efforts to build momentum for further privatization in the federal Medicare program came up short. The existing Medicare+Choice (M+C) program was plagued by withdrawals and service reductions by private health plans. It failed to gain more than a handful of plan participants representing newly authorized types of options, such as preferred provider organizations.

But the proponents of competition don’t give up easily. Renewed efforts are underway to improve and expand private health insurance options for seniors.

Medicare+Choice in Decline

The 1997 Balanced Budget Act (BBA) attempted to address several problems plaguing the Medicare program, including the fact that private plan alternatives to traditional fee-for-service (FFS) Medicare were limited to health maintenance organizations (HMOs) available primarily to seniors in larger metropolitan-area markets.

The BBA did manage to achieve significant cost reductions, largely by reducing payments to doctors and hospitals. It also launched a Medicare+Choice (M+C) program intended to make it easier for seniors to opt out of FFS Medicare and acquire health coverage in the private sector.

Even though the M+C program aimed at offering consumers more choice, only about 14 percent of the 40 million Medicare beneficiaries were enrolled in a private plan during 2001—a smaller percentage of Medicare beneficiaries than before the 1997 BBA. As of August 2001, the number enrolled in M+C was 5.6 million, down 10.5 percent from the December 2000 total of 6.26 million enrollees.

The decline in enrollment was accompanied by a sharp reduction in the number of plans participating in M+C. In 2001, withdrawals and reductions affected an estimated 934,000 M+C enrollees. At the beginning of January 2002, another 536,000 enrollees were likely to be dropped from M+C plans curtailing their participation in Medicare.

The BBA had expanded the authority of the Health Care Financing Administration (since renamed the Centers for Medicare and Medicaid Services, or CMS) to fund a variety of private insurance policies as voluntary alternatives to the traditional Medicare FFS program.

The private insurance options included health maintenance organizations (HMOs), preferred provider organizations (PPOs), provider-sponsored organizations (PSOs), private fee-for-service (FFS) insurance plans, and medical savings account (MSA) plans. Very few insurers offering PPOs have applied for an M+C contract since the BBA passed (two M+C plans currently offer PPO products), and no insurance carrier has offered a Medicare MSA plan.

Sterling Life Insurance began offering the first private FFS option in July 2000 and currently operates in about two dozen states (primarily in rural areas where other M+C options are not widely available). It offers open provider choice, combines Medicare and supplemental benefits, and pays providers on a fee-for-service basis. As of August 2001, it served just 18,000 Medicare beneficiaries, but its enrollment was growing.

Small Step in the Right Direction

M+C represents a small step toward a different system of health care financing, based on “defined contributions.” It allocates government payments to private insurers on the basis of individual county rates multiplied by risk factors for each beneficiary covered in a given private M+C plan. These risk factors are supposed to reflect the expected cost of serving each person.

It should be easier to control total Medicare expenditures if more beneficiaries receive M+C defined contribution payments instead of Medicare FFS reimbursements for a set of defined benefits. Paying a fixed dollar amount per person is more predictable than paying after-the-fact for a set of promised services.

Before passage of the BBA, there was tremendous variation in county-level per-capita spending in the Medicare FFS program, depending on differences in the utilization of Medicare and the local costs of medical services. Beneficiaries in higher-spending areas gained the advantage of relatively higher payment rates for private plan alternatives, which attracted more HMOs (and more generous supplemental benefits packages) to their areas.

Politics Stymie Competition

The BBA established a new payment method, designed to limit geographic variation in M+C payment rates. Congress decided to increase payments to M+C plans in counties with low rates and limit increases in higher-paid counties. However, the new BBA payment rules have had only a modest effect in “compressing” the range of county payment rates thus far.

The BBA also tried to address other concerns: for example, that Medicare’s payment method for private plans failed to adjust for the fact that beneficiaries enrolled in HMOs generally were healthier (and less costly to insure) than those who remained in the traditional Medicare FFS program. Inadequate “risk adjustment” added to the uneven pattern of enrollment in private plans and wide variation in their benefits packages.

The pre-BBA payment rules for Medicare managed care meant the program paid too much in some markets (particularly for plans that enrolled healthier beneficiaries) and too little in other markets. Those payment policies limited the benefits from more efficient managed care and discouraged beneficiaries from making cost-conscious choices. The BBA required HCFA to begin making payments to M+C plans on January 1, 2000 using a new risk-adjustment method that took into account health status differences among their beneficiaries, in order to reflect more closely the expected cost of serving each person.

There were so many objections to the new risk adjusters (particularly the use of data from ambulatory settings and other non-hospital in-patient encounters) that Congress first stretched out the transition to full risk adjustment, and then largely set the requirement aside until 2004. In September 2001, CMS Administrator Thomas Scully suspended collection of ambulatory encounter data for a year and put further implementation of risk adjustment on hold.

Payments based on diagnoses as well as demographic factors may eventually give insurers more incentive to keep patients who have potentially costly problems. Thus far, the new risk-adjustment rules for payments have had little effect in that regard.

Framework for Reform

In response to the above trends and developments in the M+C program, the Bush administration on July 12, 2001, offered The President’s Framework to Strengthen Medicare. The plan included a voluntary drug discount plan for Medicare seniors, but its administrative implementation was delayed by a court challenge. The rest of the framework proposed principles rather than legislative details. It emphasized:

  • Current seniors (and those near retirement age) must have the option of keeping their traditional Medicare benefits “exactly the way [they are] today.”
  • A range of new, competing Medicare plan options must offer subsidized prescription drug benefits.
  • Medicare should provide true stop-loss protection from high expenses; impose no cost-sharing for preventive benefits; and charge lower co-payments for hospitalizations.
  • Medicare should encourage high-quality care and provide better benefits.

The President underplayed several of the key ingredients needed to make such improvements affordable: allowing private plans to bid to provide required benefits, letting beneficiaries capture the savings from less-costly options, and eventually requiring the government’s share of Medicare funding to reflect the average costs of the mandatory benefits provided in private plans as well as traditional Medicare (a level-playing-field payment system).

Promising Demonstration Derailed

However, a once-promising vehicle for demonstrating the benefits of competitive alternatives to Medicare price controls—the Medicare competitive pricing demonstrations originally mandated by the BBA—was derailed by a congressional appropriations rider in November 1999. When the final report of the Competitive Pricing Advisory Committee was issued on January 19, 2001, it concluded “the key impediments to competitive pricing are not conceptual or practical, but rather political.”

Relatively little congressional activity toward Medicare reform occurred during 2001. Senators John Breaux (D-Louisiana) and Bill Frist (R-Tennessee) reintroduced their Medicare Preservation and Improvement Act (S 357), which would create a competitive premium system in which both traditional Medicare and private plans would submit premium bids for the “standard” and “high option” plans they decided to offer. Beneficiaries would receive varying levels of “premium support” subsidies (no more than 85 percent of the national average premium), depending on the premiums charged for a particular plan’s “core benefits.” The proposal sets various regulatory limits on the range of private plan competition, in such aspects as cost sharing, benefit design, and service area.

Sen. Bob Graham (D-Florida) introduced a more limited measure, The Medicare Reform Act of 2001 (S 1135). The bill focused primarily on improving the FFS Medicare program and integrating a new prescription-drug benefit into the traditional program’s structure. The bill would provide CMS with additional resources and authority to implement purchasing, contracting, and quality improvement techniques (coordinated care, disease management, competitive pricing, preferred provider options) that have been used successfully in the private sector.

Neither the Breaux-Frist bill nor the Graham proposal moved toward any formal markup at the committee level during 2001.

Reform Badly Needed

The long-term route to greater privatization of Medicare choices remains moving from the program’s traditional defined benefit structure to a defined contribution/premium-supported model, under which seniors could choose among competing benefit packages with taxpayers’ costs capped at preset levels. Healthy competition would give the FFS Medicare program an incentive to improve and fight for market share on a level playing field. Seniors seeking supplemental benefits would pay additional premiums reflecting their marginal costs, and their value.

Defined contribution payments would need to be determined by competitive market prices, instead of bureaucratically administered prices. Competitive bidding mechanisms and reasonable ground rules for periodic open enrollment would provide the best mechanism for this task, but political support for those tools has been fleeting at best.

Tom Miller is director of health policy studies for the Cato Institute. This article is excerpted from his contribution to Privatization 2002: 16th Annual Report on Privatization, published in April 2002 by the Reason Public Policy Institute. For more information on the report, visit RPPI’s Web site at