Medicare’s Private Option

Published March 6, 2014

National Review Online

Supporters of Obamacare frequently contend that the health-care law, now being implemented nationwide, is really just a version of a Republican reform plan. As they describe it, the law is built on consumer choice and competition among private insurers. What could be more Republican than that?

Of course, this superficial description of Obamacare skates past the law’s massive shift of power and authority to the federal Department of Health and Human Services (HHS) and the sidelining of individual, employer, and state decision-making roles in the process. HHS now has the power to decide every important question regarding what kind of insurance Americans must purchase, where they must get it, and how much it will cost. The law also imposes costly and job-destroying mandates on individuals and businesses, raises taxes by at least a half-trillion dollars, and piles a massive new entitlement obligation on top of the unaffordable ones already on the federal books. If you are willing to ignore all of these elements that push U.S. health care toward centralized, and costly, government control, then sure, maybe a Republican or two could support it.

When it was being considered, no Republicans in Congress were willing to look past Obamacare’s clear aim, which was to move U.S. health care as much as politically possible toward a fully government-run system. If Obamacare retains a surface resemblance to a private-sector-driven, market-based system, it is only because those who wrote it and pushed it through Congress believed they could go no farther in 2010 without fragmenting the coalition in support of the legislation. There should be no doubt about the overall direction, though: Obamacare is a massive step toward centralized government control, and that was its purpose.

This explains why the same administration that claims to be implementing a market-based reform for working-age Americans is simultaneously trying to undermine the only market-driven elements now operating in Medicare — namely, the Medicare Advantage program and the prescription-drug benefit. The apparent contradiction is actually an indication of consistency. The administration and its supporters distrust markets, consumer choice, and competition in health care, so they devised an approach for working Americans that minimizes these elements as much as possible, while handing over to HHS the power to impose ever more stringent regulations in the future. At the same time, in Medicare, which is already dominated by a government-run insurance option, the administration’s objective is to strangle and eventually eliminate those aspects of the program that are outside full government control.

The consequences of an effort to squelch competition in Medicare would be significant. Although Medicare has only about 49 million enrollees (out of a population of 316 million), the program has an outsized influence on the structure and direction of American health care. In particular, Medicare heavily influences how the nation’s network of hospitals and physician groups is organized. This is why the Medicare-reform vision of Representative Paul Ryan (R., Wis.) — based on what is called premium support — is so important. If the program were to move toward genuine consumer choice, with the government-run Medicare option competing on a level playing field with private plans, and with the consumers having an incentive to pick high-value, low-cost coverage to keep their premiums down, pressure would build for both the government option and the private plans to hold down their costs. This, in turn, would put pressure on hospitals and physicians to hold down their own costs and provide more convenient and higher-quality services to their patients. It is a vision that could transform Medicare, and begin to transform all of U.S. health care. Which is exactly why the Obama administration views it, along with the market-based elements of the current Medicare program, as the primary threat to its statist vision of health care.

Medicare Advantage (MA) has been targeted by the administration for deep cuts since early in 2009. MA plans are private-insurance options in Medicare. Seniors can elect to receive their benefits through an MA plan instead of the traditional, government-run insurance option. For seniors electing to enroll in MA, the government pays a fixed monthly amount to the plans, and the plans then must provide the entire Medicare package of services. These plans have proven very popular, especially in recent years. Enrollment in them now exceeds 14 million people, or more than one in four Medicare participants.

The administration and its allies complain that MA growth has been fueled by overpayments to health-care providers, and that was their justification for including large MA cuts in Obamacare. Of course, these cuts were also useful in transferring resources out of Medicare to pay for Obamacare’s large subsidies to expand health-insurance coverage for those under age 65. According to the Congressional Budget Office, Obamacare’s MA cuts will total more than $150 billion over ten years, including $14 billion in 2015 alone.

It is certainly true that MA plans are paid rates that exceed the costs of the traditional Medicare program in many parts of the country. But this is due to the anti-competitive structure of Medicare. The default option in Medicare is enrollment in the government-run fee-for-service insurance program. Enrollees pay the same national premium, regardless of the cost structure of the local program or the alternative private options. The government also imposes regulated payment rates on doctors and hospitals, whereas MA plans must negotiate contracts with their networks of providers. In addition, many Medicare enrollees have an employer plan that ensures they will pay no cost at the point of service for their care.

All of these features distort competition between the traditional program and MA plans. So far, instead of removing the distortions and leveling the playing field, Congress has decided to set payment rates for MA plans that make them attractive to enrollees.

But the fact that Medicare pays MA plans above the costs of the traditional program does not imply that MA plans are less efficient. In fact, they are not. According to the Medicare Payment Advisory Commission, or MedPAC, MA plans are able to deliver the Medicare package of benefits for about 96 percent of the traditional program’s costs. And MA HMOs are even more efficient, providing Medicare benefits at just 92 percent of the traditional program’s costs. MA plans use the higher payments from the government to provide additional benefits to their enrollees, including lower deductibles and cost-sharing requirements than those of the traditional program.

The Obama administration is well aware of these facts, and it is adamantly opposed to true competition in Medicare — that is, providing beneficiaries the same fixed level of support regardless of what coverage option they select. Under such an arrangement — known as premium support — if the traditional program costs more than an MA plan, beneficiaries would have to pay the added premium themselves. Several studies have confirmed that a truly level playing field would lead to large-scale migration out of the government-run fee-for-service option and into the privately administered MA plans.

But in order to create a Ryan-like level playing field, it is critical first to have a vibrant private option in Medicare that will lay the foundation for genuine competition. This is why the current skirmishing over MA payment rates is so consequential. The Obama administration is determined to proceed with the planned cuts in Obamacare, and to add to them with administrative decisions that would cut MA rates still further. Oliver Wyman, a consulting firm, has estimated that the MA cuts the administration is seeking for 2015 (more on that below) would reduce MA rates by 5.9 percent, on top of the 4 to 6 percent cut already implemented in 2014. The MA plans would have no choice but to adjust to these cuts by scaling back coverage and raising premiums and cost-sharing requirements for their enrollees. The cumulative effects would raise annual costs for MA enrollees by as much as $1,700.

To their credit, Republicans in Congress have seized on these cuts as a political issue and plan to make them a central theme in the 2014 midterm elections. The Obama administration would like to characterize the reductions as cuts for the insurers offering the plans, but the seniors enrolled in the plans know better, because they have experienced changes in their costs when the government has cut payments to MA plans in the past. There are indications that political pressure is already building. Nineteen Senate Democrats recently signed a letter complaining to the Obama administration about the cuts. If put to a vote in Congress, the cuts almost certainly would get canceled or significantly scaled back.

The other competitive component of Medicare is the drug benefit — which is actually a prototype of a full-fledged premium-support plan. The government’s contribution toward drug coverage is determined entirely by competitive bids from plans offering prescription-drug insurance. The government calculates the enrollment-weighted average of those bids and provides a percentage of that amount to the beneficiaries as their entitlement to drug coverage. The beneficiaries then apply this payment to the plan of their choice, and pay any additional premium themselves. This design, which is exactly what Paul Ryan envisions for the rest of Medicare, ensures that the beneficiaries are cost-conscious and eager to enroll in low-premium, high-value plans.

By every measure, and especially by the standard of restraining cost growth, the drug benefit has been a success. In 2014, for the fourth year in a row, premiums owed by enrollees in prescription-drug plans have remained flat, at about $31 per month, on average. This is four dollars below the premium that the Congressional Budget Office predicted at enactment (in 2003) would be required in 2006. Total costs for the program are more than 40 percent below the original estimates. And the CBO has also concluded that the drug benefit has improved the health of seniors, thus lowering costs in the rest of Medicare. It is very rare indeed to find a new federal program that comes in under budget and yet surpasses expectations for customer satisfaction and quality.

The Obama administration regularly sends out officials to downplay these achievements. It has also dreamt up supposed problems in the program — such as too many plan offerings, and the use of preferred pharmacies — in an attempt to justify a massive and costly 700-page regulation, issued as a proposed rule in January. If adopted, the regulation would severely limit the cost-cutting strategies of the drug plans, require them to contract with essentially all pharmacies in a community, and give the government the authority to stick its nose into drug-pricing negotiations. The effect would be a massive increase in the program’s costs in 2015 — as much as $1.6 billion more than what they would be under current rules. The result would be higher premiums for seniors, and reduced choice. This is the quintessential bloated, bureaucratic solution in search of an actual real-world problem.

As with the proposed Medicare Advantage cuts, Republicans in Congress have pounced on this clumsy overreach of the administration — and they will have a lot of allies in the coming fight. Patient advocates have recognized that heavy regulation of a benefit that is working will only impede access to care for those with difficult and costly medical conditions. The GOP would be wise to highlight the problems these higher costs would cause for very vulnerable and frail seniors.

President Obama long ago signaled his disdain for the belief that competition and market forces could work to improve the nation’s health-care system. Unfortunately for him, private plans and a prototype for true competition already had a foothold in Medicare before he took office. They were working well, and seniors liked what these arrangements provided for them. The administration’s efforts to roll back these popular features of Medicare are thus setting in motion a major political backlash among elderly voters. The GOP need only channel it to good use in November.

James C. Capretta is a senior fellow at the Ethics and Public Policy Center and a visiting fellow at the American Enterprise Institute.

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