Plan Competition and Consumer Choice in Medicare: The Case for Premium Support Joseph Antos American Enterprise Institute Part of the RWJF/AEI series: Preserving Medicare for Future Generations: Market-Based Approaches to Reform APRIL 2013 2 Plan Competition and Consumer Choice in Medicare: The Case for Premium Support edicare provides health coverage projected spending rising much faster than Mfor 50 million seniors and disabled revenues even after the economy recovers.2 people. The program is projected to spend The commission pointed to the need to slow nearly $600 billion in 2013, making it the down federal health spending as a key part third-largest category of federal spending of the plan to put the nation back on the after Social Security and defense. Over the path to fiscal health, observing that “federal next two decades, 76 million members of health care spending represents our single the baby boom generation will shift from largest fiscal challenge over the long-run.”3 working and paying the taxes that support Medicare to retiring and receiving benefits. Congress has adopted policies intended to That massive demographic shift, coupled slow Medicare spending. The Affordable with the continuing trend toward greater Care Act (ACA) includes substantial use of increasingly expensive medical reductions in Medicare’s payment rates for services, will put unprecedented strain on health care providers. Previous legislation the US ability to finance the program. imposed a 25 percent reduction in Medicare physician fees that is to take effect on Medicare has faced fiscal challenges almost January 1, 2014.4 from the program’s inception. As early as the 1970s, reports from the Medicare Even if those provisions are fully trustees warned that the program’s long- implemented, Medicare spending will term financing was in peril. Growing continue to grow more rapidly than pressure on the federal budget has led to other elements of the federal budget periodic legislative initiatives intended (including revenue), except for interest to slow Medicare spending. Despite such on the federal debt.5 Under this scenario, actions, the program continues to grow spending on the major health programs faster than the economy, both in the (Medicare, Medicaid, and insurance aggregate and on a per capita basis.1 exchange subsidies) and Social Security will crowd out other policy priorities. But the recent recession and anemic The Congressional Budget Office (CBO) economic recovery have put new demands projects that spending for other programs on the federal budget and raised new will decline by 40 percent between 2012 concerns about the fiscal path of the and 2037. country. In 2010, the Bowles-Simpson Commission asserted that the country Congress is not likely to enforce the large had reached the moment of truth, with reductions in provider payment rates Plan Competition and Consumer Choice in Medicare: The Case for Premium Support 3 that have already been enacted. It has total spending. That policy has promoted overridden much smaller cuts in physician the use of a higher volume and greater fees consistently since 2003, and few complexity of services, a key factor in doubt that Congress will override the 2014 the growth of Medicare spending. Under reduction as well.6 The Medicare actuary premium support, beneficiaries would projects that payment reductions under the receive a fixed subsidy to cover the cost ACA would result in financial losses for of enrolling in one of the health plans 15 percent of hospitals and other providers competing for their business. Combining by 2019, worsening in later years.7 Under market competition and a fixed federal those circumstances, action to moderate the subsidy is intended to reduce unnecessary payment cuts is virtually inevitable. For that program spending without restricting reason, the Bowles-Simpson report criticized beneficiaries’ ability to choose more the “phantom savings from scheduled expensive plans if they would like. Medicare reimbursement cuts that will never This report focuses on proposals for the materialize” as painting an overly optimistic market-based reform of Medicare based on picture of our fiscal future.8 premium support, explaining the need to This is the crux of the problem with align Medicare’s financial incentives with proposals to bend the Medicare cost the policy goals, summarizing the main curve through direct legislative controls. features of premium support proposals 70% Although policymakers face strong pressure and discussing other reforms necessary to to adopt deficit-reducing measures such as modernize Medicare’s traditional fee-for- An aging population service program. The final section assesses reductions in payment rates, they also have and the entry of the strong pressures to avoid implementing recent evidence on competitive bidding them. The policy challenge is finding a way and health plan efficiency, the ability of baby boom genera- to reform Medicare that does not require beneficiaries to make sound plan choices, tion into Medicare are unsustainable political discipline. and measures to control risk selection that could otherwise drive up program cost. expected to increase Many believe that Medicare reforms based program enrollment on the principle of defined contribution can provide the framework needed to INCENTIVES AND MEDICARE by about 70 percent slow program spending while preserving SPENDING by 2035. beneficiaries’ access to high-quality services and promoting continued medical Growth in Medicare spending is driven by innovation. A number of proposals broadly a variety of demographic, technological, referred to as “premium support” would and policy factors. An aging population and replace Medicare’s current defined-benefit the entry of the baby boom generation into system with a defined-contribution one. Medicare are expected to increase program enrollment by about 70 percent by 2035.9 Under the defined-benefit approach in use As new medical technologies and services for traditional Medicare, the program pays are developed and adopted, both the use of for all covered services without limiting services by Medicare beneficiaries and the Plan Competition and Consumer Choice in Medicare: The Case for Premium Support 4 cost of those services are likely to increase. Controlling Prices in Traditional More beneficiaries will use more services Medicare. Medicare has relied primarily that are more effective in treating disease, on payment policy to slow the growth of which will lead to longer lives. But this program spending. That has meant limiting increasingly older population will likely the amount Medicare pays for services and require even more services. changing the way payments are made to discourage the unnecessary use of services Although the program’s total spending and promote lower-cost care. depends on both the prices paid and the volume and complexity of services used, Payment incentives are crucial in Medicare has avoided policies that directly determining how health care is delivered affect the use of services or that manage the and what it will cost. This is demonstrated care of patients. In establishing Medicare, by Medicare’s shift from cost reimbursement the Social Security Act prohibited federal to prospective payment, beginning with interference with the practice of medicine.10 the inpatient hospital prospective payment 12 The program has erred on the side of system (PPS) in 1983. paying for more services and covering Under cost reimbursement, Medicare greater costs if the physician’s clinical paid the cost charged by providers for decisions are consistent with the standards each specific service used in treating an of medical practice in the local community. individual patient. Additional services Initiatives focused on improving the quality resulted in additional payment. Under of care, such as Quality Improvement prospective payment, a fee is set in advance Organizations and case management for that covers the typical cost of caring for high-cost beneficiaries, appear not to have patients with a specific medical diagnosis. 11 slowed the growth of program spending. Providing an additional service directly related to that diagnosis would not generate The design of traditional Medicare, additional Medicare payments. which pays on a fee-for-service basis and offers an essentially uncapped subsidy, Changes in payment incentives can induce has fostered rapid expansion in the use of dramatic changes in medical practice. health care. Providers have an incentive to For example, inpatient lengths of stay offer additional services to increase their dropped significantly after hospital PPS was Medicare payments. Patients are not likely implemented. With a fixed payment based to object to, or even be aware of, the cost on the needs of a typical patient with a because most of their out-of-pocket costs are particular diagnosis, an additional inpatient covered by supplemental coverage through day would not produce additional revenue as Medigap, retiree plans, or Medicaid. Lack of it did under cost reimbursement. Changes in coordination among providers in traditional the management of inpatient care, including Medicare also contributes to duplication and shortening lengths of stay, reduced hospital waste that adds to program spending. cost and increased hospital margins. Plan Competition and Consumer Choice in Medicare: The Case for Premium Support 5 However, the prospective payment incentive One feature common to Medicare to reduce unnecessary hospital cost