The Medicare Disadvantage

DANA GOLDMAN, director of USC’s Schaeffer Center, ADAM LEIVE, graduate student at University of Pennsylvania and DANIEL MCFADDEN, senior fellow, Schaeffer Center.

This op-ed originally appeared at the New York Times.

One question at the center of the Medicare debate is whether private insurance companies have a future role to play in the huge federal program. Paul Ryan’s 2012 budget proposal gives private health plans a starring role in the form of a voucher program. But some economists would give them the hook, citing the failure of Medicare Advantage to control costs. Some perspective is in order.

Medicare Advantage has historically cost 7 to 12 percent more than traditional Medicare, according to the Medicare Payment Advisory Commission. But to conclude that this cost difference proves that private health plans have no place in Medicare misreads the Medicare Advantage experience in an important way: It ignores the decisive role that government has played in driving up the program’s costs. Medicare Advantage is only partly about reducing costs. It is also designed to increase choice for beneficiaries. And the incentives that government gives private health plans to expand choice end up undercutting efforts to save money.

Under Medicare Advantage, private plans deliver Medicare services directly to patients. Insurance companies bid to provide Medicare beneficiaries with a different package of services than traditional Medicare, but their coverage must be at least as generous. The government then reimburses the insurers to cover about 13 million enrollees, or about 27 percent of the Medicare population.

Both insurers and consumers are making choices. Beneficiaries opt out of traditional Medicare if they think a private plan offers them a better deal, and insurers enter the Medicare Advantage market if they believe it will be profitable. The crucial point is that both consumers and insurers need an incentive to take part in the market. That costs money — and it is the government that has chosen to pay the price to give beneficiaries more choices. The result is that insurers compete by covering more services rather than by reducing premiums and improving efficiency to remain profitable at lower premiums.

Many contend that the government “overpays” for people enrolled in private plans, since traditional Medicare could have covered these patients for less money. But the reason it would have cost less is partly that the government has done a woeful job in figuring out how much to pay the private plans. The government compensates insurers based on the health of their enrollees at the start of the year. Plans with healthier patients receive less money than those with sicker ones to reflect the likelihood that healthier people will use less care. Healthier patients enroll in Medicare Advantage plans, so in, principle, plans should be reimbursed less by the government for enrolling these patients (the technical term for this process is “risk adjustment”). But for decades, the government has failed to determine who is healthy and who is sick with any precision, with the result that private plans receive larger payments to cover their patients’ costs than necessary. This botched payment system gives insurers an incentive to spend more time selecting the healthiest patients, and less time treating them more efficiently.

Medicare officials will counter that Medicare Advantage plans are forbidden from excluding individual patients — and they are right, to an extent. But a more egregious source of overpayments comes directly from insurers’ unrestricted choice of geographic markets in which to operate. The economists Thomas McGuire, Joseph Newhouse and Anna Sinaiko found that, for many years, private companies aimed at richer, urban areas because these were more profitable, in part because government payments to insurers must be based on the costs of traditional Medicare, which are higher in these areas.

In rural areas, by contrast, marketing costs are higher, and physicians and hospitals – being fewer – have more bargaining power with insurers. To induce private insurers to enter this market, the government increased reimbursements to them and, as expected, more companies then offered health care plans.

The dynamic here is straightforward: When faced with a choice of expanding choice (and spending money) or controlling costs by forcing competition on premiums, the government has selected the former.

The reason is not difficult to discern: politics. As part of the changes in 2003 — when Senator Chuck Grassley, an Iowa Republican, headed the Senate Finance Committee — the government paid insurers the highest of four different rates to encourage participation. At a minimum, plans were paid traditional Medicare rates, but under certain conditions they could be paid more. In a 2007 hearing before the Senate Finance Committee, Senator Grassley described the fevered politics surrounding the 2003 Medicare changes, when many senators (from both parties) lobbied for higher payments to private plans. In his statement, Senator Grassley argued against equalizing payment levels between traditional Medicare and Medicare Advantage, saying members on “both sides of the aisle” wanted to promote the availability of these plans, especially in rural areas.

So it’s no surprise that Medicare Advantage costs would reflect this generosity; that is the way the government set it up. Even when private plans save money, Medicare forces the plans to provide more generous benefits, which only encourages more care and even higher costs. These extra benefits include dental services, vision care, hearing aids, podiatry, and other supplemental services. More than half of the Medicare Advantage plans offer some form of gym or health club membership, for example.

So the truth about Medicare Advantage is not so simple. Furthermore, the program’s experience poses a more relevant and nuanced question, namely: If we actually set up the system to save money — and required everyone to make a choice — what would happen?

The new Medicare prescription drug program provides a partial answer. In this program, the government has a fixed contribution to drug benefits. Consumers choose from an array of plans — although there is evidence that they have trouble taking advantage of the complex choices they are offered. Still, the Part D market appears stable and efficient, indicating that competition with reasonable management of the products offered in the market can work.

The real question is whether a level playing field, with carefully designed and managed competition in private health insurance, can fulfill its promise and deliver enough cost savings and gains in consumer choice to be decisively superior to traditional Medicare. It’s an experiment worth trying.

3 comments for “The Medicare Disadvantage

  1. Omar Saulter
    June 25, 2013 at 4:46 am

    Medicare offers all enrollees a defined benefit. Hospital care is covered under Part A and outpatient medical services are covered under Part B. To cover the Part A and Part B benefits, Medicare offers a choice between an open-network single payer health care plan (traditional Medicare) and a network plan (Medicare Advantage, or Medicare Part C), where the federal government pays for private health coverage. …”`

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  2. January 18, 2013 at 1:43 pm

    The only Disadvantage the medicare gives us is the lack of Latest Equipment in the clinics as not many clinics are willing to show up there equipments to the people who come with Medicare in there hands !

  3. January 6, 2013 at 3:15 am

    It is usually high priced or economically draining if you’re purchasing a policy that you don’t need. These insurance plans specified to cover the gaps in the original Medicare insurance plan.

    There are a small number of vendors regarding Medicare health insurance. Its not all insurance carrier markets supplemental insurance policies.

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