A New "Definition" for Health Care Reform

The principal divide in American health care policy is over what to do about rapidly rising costs. On one side are those who believe the solution is to enhance the government's power to direct the system's resources and enforce budgetary controls. This point of view animated the drafting of the recently passed health care law. On the other side are those who believe the answer is a functioning marketplace for insurance and care, not coercion and heavy-handed regulation. The key to such a competitive market is cost-conscious consumers, something sorely lacking today.

In Congress, the new House majority plans to pass a bill to "repeal" last year's health law. That's a start (even if the odds of enactment are long for now), but House leaders know that repeal of ill-advised legislation on its own will not fix health care's complex challenges.

The new health care law would make matters worse by moving millions of new enrollees into heavily subsidized, third-party insurance arrangements.

Pro-competition, pro-consumer-choice advocates should press for reforms that would begin to convert existing, federally subsidized arrangements from open-ended benefit guarantees into "defined contribution" programs. The comprehensive and strategic approach we propose would apply defined contribution financing by taxpayers to all three major insurance coverage platforms--Medicare, Medicaid and private health insurance.

The defined contribution revolution is already well underway in private pensions. In 1985, some 80 percent of all full-time U.S. workers were enrolled in defined benefit pension plans sponsored by their employers. By 2006, the number had dropped to just 20 percent.

However, this wholesale shift has not yet occurred in the health care context, largely because the vast majority of Americans are in comprehensive insurance arrangements that are heavily subsidized by the federal government. Further, these subsidies are generally without limit. Incentives for employers as well as workers and consumers to economize and seek better value are thus substantially muted by existing government policy.

The new health care law would make matters worse by moving millions of new enrollees into heavily subsidized, third-party insurance arrangements (either through Medicaid or state health benefits exchanges)--the very kind of open-ended financing arrangements at the heart of today's cost escalation problem.

The prescription drug benefit, added to Medicare in 2003, provides one partial model for how to move toward a defined contribution approach. The government's payment for a beneficiary's Medicare drug coverage is fixed through competitive bidding each year, and it remains the same regardless of which plan the beneficiary selects. Seniors selecting more expensive plans than the average bid must pay the additional premium out of their own pockets. Those selecting less expensive plans get to keep the savings. Scores of insurers entered the program and competed aggressively with each other. The result is that costs were driven down, and federal spending came in 40 percent below initial expectations.

A similar but improved "premium support" structure could be developed for the overall Medicare program, as was recommended by a majority of members of the 1999 National Bipartisan Commission on the Future of Medicare. To properly move the broader set of Medicare-covered health benefits toward this defined contribution approach requires inclusion of the traditional fee-for-service Medicare program, not just private plan alternatives, in the competitive marketplace. Medicare fee-for-service, currently run by the Centers for Medicare and Medicaid Services, would instead be administered on a regional basis. Congress could still set its basic rules of the road and operating policies. But the program's administrators would need to be given more leeway to respond to new market signals and competitive pressures. They would be running a public program that must sustain itself entirely from the government's fixed contribution and beneficiary premiums, while meeting the same requirements applied to its private plan competitors. In paying hospitals, physicians and others, these fee-for-service programs would need to move away from imposing fees and toward an approach that would reflect market prices needed to build a network of willing providers.

The defined contribution approach to reforming the tax treatment of health insurance would focus on restoring a more level playing field for all purchasers. The current tax exclusion for employer-sponsored health insurance manages to be inequitable, inefficient and increasingly ineffective-all at the same time! And, the new health law's "Cadillac tax" on high-cost employer plans would send confusing incentive signals-if it's ever implemented almost a decade after enactment. The most important reform objectives of tax equity and greater cost consciousness both point toward flatter, fixed-dollar refundable tax credits as a starting point. From there, some adjustments may be necessary, such as those that would take into account enrollees' differences in income, health risk status and geographic location.

Moving toward a universal, fixed dollar tax credit would represent a different, but real, "universal coverage" alternative to the new health law. Every American household would get a tax credit that could only be used to purchase health insurance and health care services. Any household that didn't buy coverage would lose the entire value of the credit. The number choosing to do so would likely be very small.

Medicaid remains separate and not equal to the rest of the insurance system for working-age Americans. Its current structure provides no coordination or transition between Medicaid coverage and private health insurance. A move to replace both traditional Medicaid assistance and the tax preference for employer-paid health insurance with defined contribution payments would open up new possibilities for more beneficial coordination between both types of coverage. Integrating coverage options for the poorest Americans into the choices available to those with higher incomes will not be easy, in light of broader fiscal and political constraints, but it should proceed with all deliberate speed.

Moving toward defined contributions across Medicare and Medicaid, as well as employer-based plans, involves a complex transition well beyond just hitting new budgetary targets. Even the "Roadmap" offered by new House Budget Committee Chairman Paul Ryan, R- Wis., which fully embraces the defined contribution concept, needs a robust infrastructure for health information, better insurance markets and further navigational assistance for beneficiaries to reach its full cost-cutting potential. Nevertheless, it's clear that taking the defined contribution route to health reform would create tremendous competitive pressure on the entire health sector to deliver more for less. Any player that did not step up would risk losing market share. That's the way to slow rising costs while also improving, not compromising, quality.

Converting to defined contribution payments also will foster a more transparent political discussion over where and how to place limits on what is provided through taxpayer subsidies, while still allowing additional support for low-income households. Most importantly, it will set in motion a competitive dynamic from which all Americans would benefit.

Thomas P. Miller is a resident fellow at AEI. James C. Capretta is a fellow at the Ethics and Public Policy Center.

Photo Credit: iStockphoto/Kameleon007

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