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In the Nation's Interest

What’s Right, What’s Wrong With Medicare

By Joseph Minarik

If you want a friend in Washington, get a dog.  If you want to lose your friends in Washington, talk about Social Security or Medicare.

I feel free to write this post only because I have no friends left.

What’s right with Medicare:  Many (probably not all) people who believe that Medicare can be – in fact must be – improved are fully aware that the program has accomplished its major objective, and is essential.  They say so, clearly.  No one listens, and those who recommend any change are accused of heartlessness toward their own parents (and every other elderly American), or worse.  But after multiple attempts at even-handed discussion I have nothing left to lose, and completeness requires one more try at articulating the positive as well as the negative.  So here is what’s right:

If left to fend for themselves, far too many elderly could not obtain health-insurance coverage, and eventually would be impoverished by out-of-pocket costs – or possibly even left without care.  The Medicare guarantee changed that.  Terminating that guarantee is unthinkable.

So why even broach the subject?  The care that our elderly get from Medicare could be a lot better.  The rising cost of Medicare is the primary driver of our long-term budget problem.  A deal to fix the long-term problem is both unthinkable and impossible without reform of Medicare.  And on the basis of potentially misleading information, many have come to think that we can ignore the program’s rising costs – though procrastination might come back to haunt us later.

So what’s wrong with Medicare?

For many years, the cost of treating each individual Medicare beneficiary has been growing faster than has our gross domestic product, or GDP.  That cannot continue indefinitely.  But the problem is compounded because the Medicare beneficiary population is growing faster than the population at large, and is likely to continue to do so indefinitely – and at a rapid rate for the next quarter century or so.  In sum (or perhaps “in product,” because the two unsustainable rates of growth are in effect multiplied by each other), the math simply doesn’t work.  (Medicare cost growth has slowed somewhat for a few years.  More on that later.)

Most experts identify the problem as Medicare’s “fee-for-service” model, summarized neatly as “the more services, the more fees.”  Under that basic approach, physicians and facilities have an incentive to do anything that can be justified as beneficial for each patient – sending a bill to the U.S. taxpayer every time.  One extreme story had a former physician of an unconscious, dying elderly Florida woman visiting her room once a day to express (briefly) his concern to the attending relatives – and each time billing Medicare for a doctor’s visit.

But one need not be so cynical to be concerned.  The “if-all-you-have-is-a-hammer, everything-looks-like-a-nail” mentality is evident in medicine, as it is everywhere else.  Physicians quite naturally believe in the value of the treatments that they were trained to provide, and that they have provided over their careers – even if the evolution of knowledge has questioned that assessment, or has provided quite different and better treatments.  And health care remains short of an exact science, with far too little progress toward “evidence-based medicine.”  Research has indicated that there is considerable over-treatment – and under-treatment as well, of course.  So cost overflows, and quality suffers.

There is an alternative model.  Under “capitated prepayment,” an “integrated delivery system” – in effect, an insurance company with its own team of doctors and facilities – contracts to provide whatever services an enrollee needs for whatever conditions arise.  There is no billing for each individual service.  The professionals in the system are paid by salary, and so have no incentive to load on additional services regardless of the benefit to the patient.

But traditional Medicare was designed in a way that explicitly promotes fee-for-service medicine, and discourages capitated prepayment.  Specifically, Medicare guarantees that “any willing provider” can participate.  Capitated prepayment, in contrast, is typically built upon networks of selected physicians working as teams, which cannot be expanded to include any other physician selected at random.

So there are fundamental reasons why traditional Medicare is bound toward rapidly growing costs, most likely ultimately beyond the nation’s capacity to afford.  Still, Medicare has its defenders.  Here are some of the arguments I hear, and why they fall short of redeeming the existing model.

In ‘bundling,’ Medicare has found a way to control costs.”  Some put great weight on the concept of “bundling” of payment for a patient’s specific condition.  Under bundling, a provider is reimbursed in a lump sum for all treatment involved in addressing a particular health problem – for example, a heart attack.  That allegedly eliminates the incentive to provide unnecessary services for that condition, and on the contrary, encourages the provision of more-efficient care.  Bundling today is a broader descendent of “diagnosis-related groups,” or DRGs, which date back to the early 1980s.

Well…  DRGs once were thought to be the solution to the Medicare cost problem, and therein lies the cautionary tale.  Bundling (like DRGs) is just a poor imitation of capitated prepayment, applying to only part of a patient’s overall care.  The limitations of this poor imitation are several.  For example, the lump-sum reimbursement is determined by the particular diagnosis made by the physician.  After a short encouraging period after the introduction of DRGs, physicians began to get the idea of choosing a plausible alternative DRG that would be reimbursed at a higher rate, or even to claim multiple DRGs for a single episode.  One of the ironic unintended consequences of the current promotion of electronic medical records is that some providers have used technology to find the most lucrative diagnosis that corresponds to any particular observed symptoms.

Another potential problem with bundling arises when a diagnosis yields a single reimbursement amount for a condition that logically requires collaboration among two or more physicians who operate independently within the Medicare fee-for-service system.  Who gets the money?  Or how should it be divided among the improvised “team?”  Medicare can try to patch the system after the fact, but there are all sorts of complications that would be absent under capitated prepayment, where all conditions are a part of one big “bundle,” and no division is necessary.

Medicare has very low overhead, and Medicare is attacking fraud.”  Some boast about Medicare’s very low costs of processing and paying its bills, and point to successful identification of bad actors who have over-billed the system.

Presenting these two arguments together should be a dead giveaway:  Medicare has fraud in the first place in large part because it has low overhead – coupled with the fee-for-service model.  Medicare’s reimbursement mechanism is designed for fast, massive throughput.  It is not designed for selectivity.  And the fee-for-service model, with a transaction (in effect) for every service, generates a massive volume of transactions – with every transaction presenting an opportunity for fraud.  Capitated prepayment generates one transaction per person per month or year, and so the scope even for attempted fraud is quite limited.

Two fairly obvious follow-on points:  First, as Medicare increases its use of bundled payment by diagnosis, each aggressive diagnosis enters a grey area of interpretation which will be extremely hard to police.  And second, because the typically hyped measure of Medicare’s overhead is overhead cost as a percentage of total billings, then every fraudulent or aggressive grey-area claim adds to the total amount of billings, and therefore misleadingly reduces the program’s measured overhead cost ratio.

The Veterans health program has made great progress and delivers excellent care, and shows that the federal government can deliver quality care under Medicare.”  The Veterans health system used to be a sad joke, but now it is a success story.  The VA has made enormous progress not just on the quality of care but also on electronic health records, which has contributed to its overall success.  Some point to the VA to argue that Medicare either does or can deliver high-quality care.

Here’s the problem with the argument for knock-on benefits to Medicare:  The VA is set up like an integrated delivery system with capitated prepayment.  It chooses its doctors, organizes them in teams, and pays them by salary.  So long as Medicare is set up to reimburse any willing provider through fee for service, it cannot and will not be comparable to the VA system in cost or performance.

The Independent Payment Advisory Board (IPAB) will solve the problem.  It is mandated to use every known technique to cut Medicare spending.”  Opinions of the Patient Protection and Affordable Care Act’s IPAB differ widely.  Some see it as the “death panel.”  Others believe that it is the savior of the federal government’s finances.  Personally, I disagree with both extremes.

I’ll ignore the “death panel” canard, which is demolished elsewhere.  The less-obvious claim is that the statute creating the IPAB “contains every idea to reduce Medicare costs,” or some such.  But what makes one believe that any law, or any group of experts convened by that law, will have every useful idea?  Or that if by some miracle it did, that that list of ideas still will be complete tomorrow?

Health plans that are motivated to offer the best care at the lowest price will look at every idea they can think of, not limited to a list of ideas from an IPAB.  And they will try to pursue those ideas in the most effective way.  Regulations from an IPAB might not yield the best outcomes.  Example:  Regulations now impose penalties on hospital readmissions, in the name of controlling costs.  One way to avoid such penalties is to keep the patient in the hospital longer in the first place (possibly collecting fees for doing so).  Does that response save money at the end of the day?  Quite possibly not.  Regulations incent providers to find the most profitable way to comply with the regulations, not to provide the best quality care at the lowest cost – which is not the same thing.  If you think that the members of an IPAB would come up with new and better ideas, add those members to the existing Medicare Payment Advisory Commission (MedPAC) – saving the additional overhead of creating a new entity – and have them publish their thoughts for the providers in a Medicare reformed to provide incentives for quality and efficiency.

Medicare’s costs are growing more slowly than those in private medicine.”  Some analysts have presented calculations that allege that per capita costs in Medicare are growing more slowly than those in the private medical system.  Such calculations are controversial, for several reasons.  For one thing, it is difficult to make an apples-to-apples comparison between the health costs of the very different elderly and non-elderly.  For another, a period of slower cost growth for a system that starts from an excessively high base may or may not indicate a full solution to the underlying problem.  But perhaps most important, if any cost attenuation has occurred because of Medicare’s cuts to its reimbursement rates, then clearly, Medicare cannot continue to fall further and further behind private reimbursements without eventual ill consequences for the access of the elderly to care.  Alternative calculations already indicate that in many instances Medicare reimbursements are below provider costs.  A battle of the surveys already raises the painful prospect that some physicians are refusing to accept new Medicare patients, reducing access and forcing new enrollees to change physicians.

Healthcare cost growth has slowed over the last few years, so it is prudent to defer decisions until we know more.  Perhaps we won’t need to act at all, and the recent healthcare reform and growing awareness of the cost problem will solve it for us.”  Healthcare cost growth has slowed.  The slowdown could continue, or even become stronger.  But no one has yet explained why it has occurred, which suggests that it would be risky to assume that it will continue.  Also pushing toward action is the fact that prior slowdowns have occurred in weak economies, always to reverse themselves when good times resume.  This cyclicality suggests that people with reduced incomes tend to stay away from the doctor when they fear that they will not be able to pay the bill for recommended services.  And given current very low interest rates, that mentality may hold for many of the elderly for some time.

We can reject the hypothesis that the cost slowdown has been caused by the 2010 health-insurance reform bill, the PPACA.  The key provisions of that bill have not yet taken effect.  The members of the IPAB have not yet even been appointed.

Another alternative hypothesis is trickier.  Some believe that healthcare providers have seen the backlash against rapid cost growth in their sector, and so have tried to hold costs down to avoid painful cutbacks from the public or government.  But that is hard to believe, given that any individual provider could continue maximizing his or her fees while waiting for others to cut back and hold their costs down.  There are some success stories among employers trying to cut their insurance costs, but there are at least as many – probably more – stories of other employers who remain squeezed by rising prices.

If we wait for the unexplained current shift in the long-term trend to save us, and that shift reverses as have similar ones in the past, then we will be that much further behind the curve of rising healthcare costs and mounting debt – and the necessary adjustments will be necessarily that much more abrupt and painful.

So what should we do?

Well, CED’s specific recommendations for Medicare are here, with more background and our perspective on health care generally here.  In summary, we believe that Medicare should offer each beneficiary a choice among competing plans, including traditional Medicare, along with a grant that would buy the second-least-expensive alternative in his or her geographic area.  If a beneficiary wants a more-expensive plan, he or she can have it, but must pay the incremental cost above the grant to do so.  If any beneficiary finds that his or her plan provides care that is not worth the cost, he or she can switch at the next open season.  Plans will have to shape up or ship out.

The easiest way to get there would be to build on the existing Medicare Advantage plan.  Already in 2012, 27 percent of all beneficiaries were enrolled in Medicare Advantage plans, and beneficiaries have on average a choice of 22 plans.  Generalizing very broadly, today’s Medicare Advantage program does not fulfill our specifications because plans are basically constrained to offer the same price, and therefore can compete only on the basis of adding additional bells and whistles of coverage.  If instead those plans could offer the same coverage as traditional Medicare at a lower price, CED believes that there would be more-vigorous competition that would reduce healthcare costs – “bending the cost curve.”

Why is it so hard to achieve such a common-sense reform?  Let’s leave aside pure demagoguery – tell today’s elderly that they will have their health care taken away, even if the change starts a decade from now, and only for then-new enrollees – and think about some of the practical hurdles.

Congressional budget “scoring” is one of those hurdles.  Selling such an idea requires demonstrating that it in fact will save money.  But in the words of Adam Smith – father of all of us economists – this reform would put the “invisible hand” of competition to work to slow the growth of healthcare costs.  But how do you measure the invisible hand?  You can’t – because it is invisible.  No one knows how much competition will hold down costs for cars, computers or haircuts over the next 10 years.  So we certainly don’t know how much competition would save in health care.  To “prove” savings under such uncertainty, most proposals for competition in Medicare include a cap on costs, with automatic increases in premiums (or reductions in reimbursements, where possible) to achieve the savings if competition does not do so.  Opponents of the idea immediately argue that the objective of the entire policy is to raise Grandma’s premiums – even if advocates can be confident that cost growth will slow without triggering the cap.  Perhaps the best way to proceed would be to put competition to work for at least some period of time without a trigger to guarantee “scored savings.”

Advocates of low-income seniors might complain that a grant that covers only the premium of the second-lowest-priced plan would de facto prevent those seniors from choosing a more expensive plan.  They wouldn’t have the money to pay the excess of an expensive premium over the grant.  Well, low-income seniors could be subsidized, up to a point.  But telling people that they can choose the most-expensive health plan without bearing any of the cost is what got us into this problem in the first place.  Moderate-income working-age Americans do not have open-ended choice of health plans regardless of expense, either.

People from rural areas might be concerned that their sparse population densities would prevent the formation of efficient integrated health plans, with the result that they would be forced to pay higher premiums.  A reasonable program design would recognize that possibility, and provide an out for rural areas unless and until there is a critical mass of viable alternatives.

And there would be a family of concerns generally related to adequacy of coverage.  Some would fear that private plans would entice the healthy, younger seniors, and then drive them away with inadequate care once they became older and sicker.  Others might worry that private plans would simply offer incomplete, inadequate care, and make money through penny pinching.  But today, a technique called “risk adjustment” is used after the fact to compensate those plans that enrolled a population of above-average risk, thereby weakening the incentive to cherry-pick healthy enrollees.  Furthermore, every employer (including the federal government) that offers choices to its employees today must police the various plans, and drum out any that do not meet minimum standards for coverage and quality.  The Federal Employees Health Benefits Plan is thought by many to be a successful model, and other employers have done well.  There is no reason why a reformed Medicare program could not be equally successful.  And any plan that was willing to acquire a reputation as a purveyor of inadequate care would surely earn a decline in enrollment and a timely demise, given the ability of beneficiaries to move to alternative plans.

In sum, although Washington and its watchers are focused on the sequester (and I have had some things to say earlier this week here on the blog), any eventual solution to our budget problem will require some diminution of the rapid growth of costs under Medicare.  We at CED have seen no viable alternative to the kind of transformation of Medicare that we have recommended.  Talking about it may not make you many friends – indeed, it may lose you those you already have – but the nation must face up to this problem, and the sooner, the better.