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Commentary By Avik Roy

Medicare Reform: Who Decides?

Health, Health Healthcare

Both parties know that Medicare is broke. So how are we going to fix it?

In an ordinary environment, it is nearly impossible for Americans to conduct a reasoned discussion about Medicare. And entitlement reform remains fraught with political peril, as the recent special election in New York has shown: Democrat Kathy Hochul defeated Republican favorite Jane Corwin, in a campaign dominated by Hochul’s attacks against Republican plans for Medicare. But it is no longer possible to avoid the truth. Medicare is bankrupt, and if we don’t make gradual but significant changes to it, the program will end America as we know it.

On a per-capita basis, Medicare spending is growing faster than the economy. On top of that, the Baby Boomers have started to retire: in 2031, when the last of the boomers reach age 65, there will be 77 million people on Medicare, compared to 47 million today. No tax increase would be large enough to keep up with the growth in Medicare spending, and so controlling spending is the only way out.

What gets lost in the debate about Medicare is that both Democrats and Republicans know that Medicare is broke, and responsible members of both parties have proposed plausible reforms of the program. Indeed, both Obamacare and the 2012 GOP budget authored by Paul Ryan would impose comparable reductions in the growth of Medicare spending. Where the president and Rep. Ryan differ is less in the “how much,” and more in the “how.” Put simply, the Obama approach puts government experts in charge of controlling costs, and the Ryan approach hands more control to individual seniors.

What does this mean in reality? How will these abstract-sounding concepts affect how doctors care for sick patients? Which one is more likely to work? It’s worth spending some time on these questions. We can start with the basics of how Medicare works today.

Health insurance is, in theory, fairly simple. Participants in an insurance plan pay monthly premiums. Those premiums, in total, should be enough to fund the actual health costs incurred by those in the plan who get sick, along with the administrative costs of running the plan. In order to ensure that premiums are as affordable as possible, insurers try to make sure that they pay for needed, but not unneeded, care. For example, a patient with a simple heartburn shouldn’t be managed as if he’d had a life-threatening heart attack, even though the two disorders often look and feel alike at first glance.

There are two tools Medicare could use to ensure that it pays for needed care and not unneeded care. The first is cost-sharing, and the second is rationing. As you will see, in our current system, Medicare does neither. Instead, it imposes price controls on physicians and hospitals, and those controls are increasingly driving doctors out of the Medicare system.


COST-SHARING INVOLVES having the patient pay for a portion of the costs of his care. This way, if a doctor orders unnecessary tests or procedures, the patient has an incentive to say: do I really need this test, if it’s going to cost me an extra $1,000? Cost-sharing comes in three forms: deductibles (the insurance kicks in after the patient has paid some minimum amount, say $3,000), co-pays (the patient pays a fixed dollar amount, say $30, to pick up a bottle of pills that retail for $500), and co-insurance (the patient pays a fixed percentage, say 10 percent, of all extra costs above the deductible).

Medicare, in theory, uses all of these tools to contain costs. Most retirees pay $248 a month for hospitalization insurance through Medicare Part A, and $96 or $111 a month for physician services and outpatient hospital services through Medicare Part B. Retirees are supposed to pay $1,132 for hospital stays of one to 60 days, $283 a day for days 61 to 90, $566 a day for days 91 to 150, and all costs beyond day 150 of a hospital stay. Similarly, for Part B, retirees pay a deductible of $162 per year, and then a coinsurance fee of 20 percent of all physician or outpatient charges above $162.

Compared to the average private-sector family insurance plan, Medicare is a fantastic deal for the consumer: very low premiums, in exchange for very low exposure to health care expenses. But, as you can see, Medicare does try to use the tool of cost-sharing to discourage seniors from over-consuming health care services. Retirees, in theory, are increasingly financially responsible for longer hospital stays, and are expected to pay a percentage of most physician and outpatient expenses.

But the theory doesn’t play out in practice, because most retirees obtain supplemental insurance that helps to wipe out the cost-sharing provisions of traditional Medicare. Many of these retirees purchase privately administered supplemental plans, called “Medigap,” that pay for the deductibles, copays, and coinsurance fees that Medicare would otherwise charge. Because these charges are largely contained, it is very inexpensive—and highly profitable—for insurers to underwrite Medigap plans. In turn, seniors on Medigap have absolutely every incentive to overconsume health care services.


THE OTHER WAY that Medicare could reduce wasteful health spending is through rationing. For example, let’s say a new treatment for malignant prostate cancer is approved by the Food and Drug Administration (FDA). The new treatment has been shown in large clinical trials to extend life, on average, by two months. The company seeks to charge $200,000 for a course of therapy with their treatment. Medicare could, in theory, decide it’s not worth it to pay that much to extend someone’s life by two months. As a result, Medicare declines to pay for the treatment.

This is not how things work today. Today, if the FDA approves a treatment, Medicare is legally obligated to pay for it, no matter what the price. (Private insurers have much more leeway in this regard.) Certain drug manufacturers are increasingly taking advantage of this phenomenon to charge extremely high prices for their treatments, knowing that the government has no choice but to pay them.

As health expenditures increase, so too do calls from the left for the government to directly intervene in this process: to refuse to pay for treatments and procedures that the government decides are wasteful. For example, the government might decide that it’s not worth it to pay for a hip replacement for a 90-year-old woman, because that woman, on average, won’t live for much longer.

The first problem with rationing is that one size does not fit all. An active, healthy, 90-year-old woman who hikes regularly might benefit from a hip replacement. Another woman of the same age, whose lifestyle is more sedentary, might not get as much out of it. When the government decides for everyone, there is no room for individual priorities and needs. Deciding what treatments are “cost-effective” is an inherently subjective process, as it depends on what you consider costly, and what you consider effective.

The second problem with rationing is that it necessarily discriminates against the elderly. One can argue that our current system discriminates in favor of the elderly: a recent study from the Urban Institute found that the average married couple that retires in 2011 will have paid $109,000 in Medicare taxes, but will receive $343,000 in benefits. Nonetheless, any technocratic attempt to rationalize what Medicare will and will not pay for eventually ends up recognizing that funding the health care of young people is more “cost-effective,” because the young will live longer and more productive lives as a result, whereas caring for the elderly—especially those in the last six months of life -- is less “cost-effective,” because the elderly don’t have much longer to live either way.

Price Controls

SO, THE MAIN TOOLS for restraining Medicare spending -- cost-sharing and rationing -- currently go unused, because the first is controversial on the left, and the second is controversial on the right, while both are controversial with retirees. What we do instead amounts to a stealth form of rationing: price controls.

In 1983, under Ronald Reagan, the Health Care Financing Administration -- forerunner to today’s Centers for Medicare and Medicaid Services -- instituted a “prospective payment system,” in which hospitals and physicians would get paid a fixed amount for a specific medical diagnosis. In this way, the government hoped to tamp down rapidly rising physician and hospital fees. Unfortunately, less scrupulous doctors and hospitals got very good at “upcoding” patients to more lucrative diagnoses, keeping spending on the rise.

Other attempts under both Republican and Democratic administrations and legislatures were similarly futile. Most notably, the Balanced Budget Act of 1997 contained a Medicare Sustainable Growth Rate (SGR), which linked increases in Medicare spending to gross domestic product growth. The SGR worked by requiring Congress to cut fees to hospitals and doctors if Medicare spending exceeded the Sustainable Growth Rate.

But this blunt instrument did nothing to change the incentives by which individual doctors and hospitals practice medicine. If a group of eight people go out to a restaurant, and agree beforehand to split the check equally, each diner has an incentive to order the most expensive item on the menu, because that diner will end up paying as much as someone who orders more frugally. Similarly, doctors and hospitals facing global cuts are further incentivized to maximize what they can get out of the system. Indeed, as growth in Medicare expenditures has continued to rise, Congress has repeatedly failed to make the mandated cuts in Medicare spending.

Instead, at the behest of the American Medical Association and the American Hospital Association, Congress has passed repeated “doc fix” provisions to keep Medicare payments in line with health inflation. The most recent of these “doc fixes,” passed in December 2010, carried a 10-year cost of $14.9 billion and postponed the inevitable reckoning by only 12 months. If Congress refuses to pass “doc fixes” in the future, physician fees from Medicare will instantly decrease by more than 25 percent.

Why does this amount to a stealth form of rationing? Because doctors are paid much more to take care of patients with private insurance than they are by Medicare or Medicaid. As a result, an increasing number of physicians are refusing to take Medicare patients. As seniors find it gradually harder and harder to land a doctor’s appointment, it becomes more and more difficult for them to gain the care they believe they have been promised.

The Fork in the Road: Ryancare, Obamacare, or Doing Nothing?

THESE THREE CONCEPTS are at the heart of the three health policy choices before us: doing nothing, embracing the rationing model of Obamacare, or attempting the modest market-based reforms in Paul Ryan’s 2012 GOP budget.

Obamacare contains an embryonic version of a rationing board, called the Independent Payment Advisory Board (IPAB). This panel, comprised of 15 individuals appointed by the president, was originally conceived as way of rationing Medicare. However, when Sarah Palin and others called IPAB a “death panel,” Democrats were forced to neuter the most aggressive rationing components of IPAB. Instead, if Medicare spending exceeds a prescribed growth rate, IPAB is empowered only to reduce payments to doctors and hospitals. Does this concept sound familiar? It should, because it isn’t that different from the old 1997-vintage SGR. Hence, whether Obamacare is repealed, or whether it is preserved in its current form, our current law continues to use the stealth-rationing approach to underpay doctors and hospitals for their services. This, in time, will force more and more doctors to drop out of Medicare.

Left-leaning health wonks hope that, over time, they can restore IPAB’s rationing powers, and in this way, bring Medicare spending under control. IPAB’s recommendations can only be overruled by a supermajority of Congress, arguably making IPAB one of the biggest transfers of power from the Legislative Branch to the Executive in recent memory.

Paul Ryan’s plan uses a different approach: individual choice and cost-sharing. Under the Ryan approach, seniors would choose among a set of privately administered, government-approved health plans -- as a quarter of retirees already do under the Medicare Advantage program. The difference would be that, gradually (starting with people age 55 today), the Ryan plan would restore some of Medicare’s cost-sharing features. The core benefits of each insurance plan in the Ryan system would be mandated by the government, but insurers would be free to offer additional benefits, and tweak their cost-sharing packages in ways that suit the needs of individual retirees. Seniors, in turn, would get to choose: Do I want the plan with the higher deductible but lower premiums? Are there certain additional benefits that I’m willing to pay extra for?

Far from being a wild-eyed, radical approach to reforming Medicare, the Ryan plan draws on the most successful American model of government-sponsored health insurance: the Federal Employee Health Benefits Plan, or FEHBP. Indeed, many bi-partisan attempts at Medicare reform, most notably Bill Clinton’s Medicare commission, recommended migrating Medicare to the FEHBP “premium support” model.

The FEHBP, founded in 1960, provides health insurance to 8 million federal employees, retirees, and their dependents. Under FEHBP, beneficiaries can shop among a diverse array of 250 privately administered health plans, each containing its own mix of additional benefits and cost-sharing features. Gradually, over time, FEHBP plans have painlessly evolved to support those additional benefits that policyholders most want, without the need for bureaucratic rationing. In addition, FEHBP has been able to provide more cost-effective care than Medicare, which is stuck in an obsolete 1960s fee-for-service model that rewards doctors for overusing health care services.

Liberals are fond of saying that “everybody rations” in both the private and public sector. But the liberal formulation glides over the most important distinction. In the single-payer systems they favor, rationing is carried out by unelected bureaucrats, whose interests and orientations are far different from those of the millions of retirees their decisions will affect. In the consumer-oriented model favored by Paul Ryan and the FEHBP, individuals choose what services they are most willing to pay for. The consumer-driven approach leaves room for different people to seek out different forms of insurance. In the government-driven approach, you either accept what the government tells you to accept, or you leave the country.

This, then, is the choice facing American voters: whether to accept the stealth rationing of today, in which doctors can no longer afford to see Medicare patients; the overt rationing of Obamacare’s acolytes, in which 15 individuals will decide the fates of one-sixth to one-fifth of the American population; or a Ryan-like system where individual retirees choose the plans and benefits that best fit their needs. Each of these systems purports to reduce Medicare spending: the question is who gets to make the decisions.

It is therefore critical that our aspiring political leaders speak honestly about Medicare. They must speak about the fact that spending reductions are coming, no matter which party is in charge. They must speak with clarity about the decisions we face. For if American voters can come to truly understand the alternatives before us, there can be little doubt as to which they would choose.

This piece originally appeared in The American Spectator

This piece originally appeared in The American Spectator