The role of Medicare fee-for-service in inefficient health care delivery

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Article Highlights

  • About 75 percent of Medicare beneficiaries (37 million) were enrolled in the fee-for-service option in 2012.

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  • Medicare’s FFS, no-cost-sharing arrangement drives high costs not just in Medicare, but in the health sector as a whole.

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  • Given Medicare’s influence over all health costs, fixing the program should top the list of reform priorities.

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Medicare is the 800-pound gorilla of American health care. The misaligned incentives embedded in Medicare fee-for-service (FFS) have affected the entire health care delivery system, driving up costs without commensurate increases in quality.

Today, nearly 90 percent of beneficiaries in traditional Medicare have supplementary insurance that pays any costs not covered by the program. Because these beneficiaries pay close to nothing at the point of service, they have strong incentives to utilize as many services as their physicians recommend, even if the expected benefit is negligible or unproven. Those providing services in Medicare FFS are also able to increase their incomes when they perform more tests and procedures on patients. The predictable result has been steady growth in the volume of services—and hence costs—paid for by Medicare FFS.

Medicare’s FFS, no-cost-sharing arrangement drives high costs not just in Medicare, but in the health sector as a whole. Medicare accounts for 23 percent of every dollar spent on health care in the United States, or up to 40 percent if you include Medicare claims paid by private supplemental insurance and the small amount of costs paid by the beneficiaries themselves. Because of Medicare’s dominant size in the marketplace, the FFS model influences the entire health system’s structure and costs. Most private insurers use Medicare FFS’s payment approach to design their payment systems. Moreover, the advent of Medicare FFS, along with the spread of employer-sponsored insurance, was responsible for about half of the real cost increase in all health care spending in America from 1950 to 1990. Areas with more beneficiaries enrolled in Medicare Advantage (MA) experience lower costs for FFS Medicare, implying that the mere presence of (more efficient) MA plans lowers costs for all of Medicare in a given region.

Given Medicare’s influence over all health costs, fixing the program should top the list of reform priorities. Regulatory approaches have failed in the past, largely because of a political dynamic that rewards volume, not quality. In the end, real improvement will almost certainly require a more fundamental change than has been enacted to date: a market-based reform that corrects the flawed incentives that drive unnecessary spending in the current program.

Other papers in this series:

Plan competition and consumer chioce in Medicare: The case for premium support, by Joseph Antos
A competitive bidding approach to Medicare reform, by Roger Feldman, Bryan Dowd, and Roger Coulam

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James C.
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