The inaugural issue of this bimonthly publication discusses key concerns blocking a legislative agreement to establish a prescription drug benefit plan under Medicare, the main federal health program for senior citizens. Those concerns involve the proposed benefit’s extent and structure, the likely private sector response to it, its effect on the rest of the Medicare program and the healthcare coverage its beneficiaries have traditionally received, and the degree of freedom private providers would have if they elected to participate in the program.
The battle in Congress over Medicare reform is beginning to resemble a siege. Debate is raging over each provision in the nearly 2,000 pages of dense legislative prose now before the conference committee. Legislation that voluminous offers numerous opportunities to trade off one provision against another, which is the stuff of political compromise.
Perhaps not this time, however. The core issues are deeply divisive, causing some to fear that the chances of agreement are rapidly diminishing. Democrats maintain that the prescription drug benefit is just not good enough, while Republicans raise the specter of program meltdown if we spend too much. Republicans see the promise of lower cost and better performance through competing health plans, while Democrats fear that competition will jeopardize the traditional Medicare program and harm millions of beneficiaries.
Both sides have valid concerns, but the rhetoric has soared beyond reality. The bills before the conference committee reflect sharp disagreements between the House and the Senate, and within the political parties, on several key points. A compromise is possible, however, if policymakers can admit that the most extreme assertions are overblown, and that some of the most hard-fought provisions might not actually work.
In that spirit, let’s take a close look at four problems that have threatened to derail the Medicare legislation. The shorthand description of each problem below is meant to capture the most pessimistic view of the issue. The ensuing discussion makes clear that all is not lost. Either the dire consequences might not be so dire, or the consequences might be avoided by changing the legislation.
Those problems cannot be resolved easily. The traditional political expedient of pouring more money into the new program would not work even if additional funds were available in the budget. Legislation could create a sensible drug benefit and put us on the path toward prudent reform, but achieving those aims will require the conference committee to rethink major parts of the proposals.
Problem 1: The prescription drug benefit is not good enough.
Perhaps the most reviled feature of the Medicare drug proposals is the “doughnut hole,” a gap in coverage that affects beneficiaries with high prescription drug costs. The lower side of the doughnut would reimburse for a portion of drug spending after the first $250 or $275. The initial coverage would cease after the individual’s spending had reached several thousand dollars. At that point, beneficiaries would be required to pay the full costs of their drugs until they had made out-of-pocket payments of $3,500 (in the House bill) or $3,700 (in the Senate bill). Insurance coverage would then resume for those with even higher expenses.
This benefit structure is confusing, unfair, and designed to fail. Imagine trying to explain to your mother that the prescription that cost her $20 last month now costs $100, but might cost her nothing later in the year. Or trying to explain to someone with an annual income of $15,000 that he is protected from high drug spending as long as he spends more than $3,000 from his own pocket.
Despite appearances to the contrary, the Republicans who came up with this scheme have not lost their grip on reality. They have a budget problem, and they are using a budget trick to solve it. Policymakers found that they could not design a simple drug benefit and give enough of a subsidy to 40 million people for them to sign up for it without spending more than $400 billion over the next decade. In previous years, Democrats would have solved the budget scoring problem by making the benefit sunset after eight years--an obvious sham, since Congress would surely not let a popular benefit expire.
Republicans have adopted the doughnut hole, knowing full well that a future Congress will fill in the gap. Sen. Ted Kennedy (D-Mass.) bluntly admitted that intention in his support for the Senate bill. The budget process promotes this kind of chicanery by ignoring the cost of future legislation to fix a serious flaw in the new program, even when that legislation is virtually inevitable.
Congress should level with us, and themselves, about the real problem: they have promised more than the government can deliver. Traditional first-dollar coverage for prescription drugs with a low premium and no benefit gap would be popular with seniors, but the cost to taxpayers would be enormous. It would not come as much of a surprise to most Americans that the cost of the big new entitlement would come directly out of their pockets. Straight talk on the real costs of the Medicare benefit would be a sobering but welcome change.
The doughnut hole can be filled without doubling federal outlays, but only by redirecting program subsidies to encourage more cost-conscious prescribing and purchasing. The most direct approach would be to reduce first-dollar coverage but add coverage for higher levels of spending. That would mean making seniors pay a substantially larger deductible than under the House and Senate bills in exchange for filling in the coverage gap. Beneficiaries could be given an additional cash subsidy provided through a Medicare drug discount card to help them pay the higher deductible. Under this approach, seniors would be sensitive to cost since they would use their own money (from their accounts) to pay the full cost of drugs until they met the deductible. In contrast, seniors in a traditional insurance program would directly pay only a portion of the cost, and would lose the value of the benefit if they did not use it.
Private drug plans are likely to find other ways to fill the doughnut hole that could be attractive to many beneficiaries. Given sufficient flexibility to experiment, plans might be able to eliminate the benefit gap by using aggressive cost-management techniques to keep premiums affordable. For example, a plan might guarantee payment for the lowest-price prescription drug appropriate for the patient’s illness. If the patient wished to buy a more expensive drug, he would pay the entire difference between the plan’s reimbursement and the price of the alternative product. That difference could be hundreds of dollars in some instances, providing an extremely strong incentive to use the drug whose payment was guaranteed. Unlike reference pricing approaches, this “reference reimbursement” model would not dictate what drug manufacturers may charge for their products. Drug plans would continue to seek low prices for their customers, but in many cases generic drugs would offer the lowest price. Reference reimbursement or similar methods potentially could eliminate the doughnut hole and keep out-of-pocket costs down, but only for beneficiaries whose prescription drug needs were met by generics and low-price brands.
Unconventional approaches to the Medicare drug benefit might not appeal to everyone, but such ideas should be given a chance in the market and seniors should be free to choose. The Senate bill precludes this sort of experimentation by imposing too many restrictions on the structure of benefits. The House bill is less restrictive, but the Medicare administrator should be given broader discretion to allow more innovative approaches. Restrictions on benefit design and other regulations in the Medicare legislation are intended to protect beneficiaries, but they may in practice prevent the development of cost-effective plans that could meet the needs of many seniors.
Problem 2: Drug plans will not compete, particularly in rural areas.
Congress can enact a drug benefit, but will private plans deliver it? Critics point out that private managed care plans have abandoned the Medicare+Choice program in droves over the past five years, and those plans that remain are huddled along the Atlantic and Pacific coasts. That leaves most of the country without a private health plan option today. The Senate bill attempts to avoid a similar problem under the drug benefit through a “federal fallback,” an unnecessary and misguided bit of policy.
Both the House and Senate bills would make a prescription drug benefit available to all beneficiaries through private health plans. Health maintenance organizations (HMOs) and preferred provider organizations (PPOs) would offer the full set of Medicare benefits, including prescription drugs. New private plans would offer drug-only coverage to beneficiaries in the traditional Medicare program. The “stand-alone” drug plans would bid to operate in regional service areas. Those plans would be at risk if the cost of providing prescription drugs to their enrollees exceeded the amount that they bid.
The bills assure that drug-only private plans will participate by shifting financial risk from the plans to the taxpayer. If enough risk is shifted away from the plans, they would be able to operate much like pharmacy benefits managers (PBMs) that run the drug benefit for most private insurance plans. They would be paid for the drugs dispensed and would profit by managing the cost of the benefit in addition to receiving a fee for handling millions of transactions. Under both bills, the Medicare administrator could reduce risk to negligible amounts if necessary to encourage plan participation.
The real novelty of the Medicare drug proposals is the requirement that private drug plans operate with financial risk, perhaps following a transition period. That would provide a powerful incentive for the plans to manage program cost. But putting plans at full financial risk in the first year of the program is a problem.
Private drug plans would have great difficulty setting their bids for the first year, when they would have no experience to help them predict the cost of the drug benefit or the patterns of prescription drug use among Medicare beneficiaries. Full-risk bids for 2006, the first year of operation, would be inflated to protect each plan from those great uncertainties. If, alternatively, the program administrator exercised the authority to reduce the initial risk, plans could safely lower their bids.
After the first year or two of operation, however, private drug plans would have detailed spending and use data as well as familiarity with administrative requirements of the program that would affect their cost. Plans would then be able to make more realistic and competitive bids, resulting in lower cost to both taxpayers and beneficiaries. Benefit structures could be refined, and more plan options would be likely to develop as plans learned more about beneficiary demands.
The Senate would short-circuit that development with the federal fallback. If there were not enough drug plans in a region, Medicare would contract with a PBM or some other company to administer the drug benefit on a fee-for-service basis, similar to the way physician services are administered today.
The federal fallback is unnecessary because the fallback plan is simply a private drug plan with (almost) no financial risk--something the program administrator could permit under both bills without invoking the fallback provision. But that provision would not be harmless. The fallback provision would require a federal formulary and price list that would chill the atmosphere for innovation in the pharmaceutical industry.
Unlike an at-risk private plan, the fallback plan would have little incentive to design an efficient, cost-containing benefit. The plan would not stand to profit by reducing program cost, with the exception of a possible bonus payment. Because a fee-for-service benefit cannot be administered without knowing what can be purchased and what price to pay, the federal government would have to approve a formulary and price list for all prescription drugs used by Medicare beneficiaries. Although the fallback plan might operate in only a few regions, the formulary and price list would be de facto national standards.
It is a short step from there to federal price controls and restrictions on patient access to new pharmaceuticals that would affect all seniors, not just those enrolled in a fallback plan. The budget savings from top-down regulation are immediate and seductive. But the consequences of such an approach are long-term and serious, discouraging the research and development that could lead to more effective and potentially cost-saving drug therapies.
Congress should focus its attention on assuring a smooth transition to a competitive Medicare drug benefit. Although the Medicare administrator will have the authority to adjust financial risk, the final bill should not impose unnecessary restrictions on private drug plans that could discourage them from participating in the program.
Reasonable legislative and administrative controls and appropriate payments based on actual operating costs are necessary to avoid a repeat of the Medicare+Choice experience. Unlike comprehensive health plans, drug-only plans should be able to penetrate rural markets without major difficulty since they would not need to organize complex networks of providers. Internet-based systems and mail order prescriptions could supplement the retail pharmacy distribution system, which might be limited. Although the problem of rural access has been one of the major driving forces behind the drug legislation, it can be readily solved.
Problem 3: Premium support will jeopardize traditional Medicare and harm millions of beneficiaries.
Medicare spending is projected to double over the next decade, and it will grow even faster after that. Adding a $400 billion prescription drug benefit will add momentum to runaway growth in the program. The House bill attempts to apply the brakes by limiting the federal subsidy given to Medicare beneficiaries. Critics charge that this would drive premiums up in traditional Medicare, jeopardizing the healthcare of millions. Yet those same critics argue that traditional Medicare is more effective in controlling costs than the private sector. One of those statements could be true, not both.
Under the premium support provision, beneficiaries who chose a more costly health plan would pay higher premiums than those enrolling in lower cost plans. The provision would require traditional Medicare to compete on a more equal footing with private plans. That matters, since more than 85 percent of Medicare beneficiaries are enrolled in the traditional program.
The House provision would become effective starting in 2010 in local markets with high levels of Medicare enrollment in private health plans. The federal subsidy for all beneficiaries in a competitive local market would be the cost of providing services to beneficiaries averaged across all health plans (including traditional Medicare) in that area. Plans with costs above that average would increase their premiums by the full difference between the subsidy and the bid. Plans with costs below that average would decrease their premiums by three-quarters of the difference (with the remaining savings retained by the government).
Critics of the House provision fear that healthy beneficiaries would leave traditional Medicare in response to lower premiums in private plans. Those remaining in traditional Medicare would therefore tend to be sicker, and the average cost of care in that program would rise. Premiums would continue to increase sharply in subsequent years as the selection of healthier people into private plans continued, making the traditional program unaffordable.
That outcome is neither inevitable nor even likely. Beneficiaries consider numerous factors in addition to lower premiums in deciding whether to change plans, and many people are willing to pay much higher premiums if they perceive that the plan offers higher value. Once in a health plan, however, most people stay enrolled, blunting the potential instability that could ensue otherwise.
The experience of the Federal Employees Health Benefits Program (FEHBP) is instructive. That program has ample opportunity for risk selection. Federal workers and retirees can choose from twelve different national plans, and they may also have a number of other health plans operating in their local markets. There are often large premium differences among those plans. Yet the system is remarkably stable, with only moderate numbers of beneficiaries switching plans each year.
The premium support provision in the House bill includes safeguards to prevent the adverse consequences of risk selection. Premium adjustments would be phased in over five years, limiting any premium increase in traditional Medicare during the transition to the new system. The subsidy calculation would be heavily weighted in favor of the traditional program (which will continue to be the dominant plan option for the foreseeable future), further reducing the potential size of any premium increase. Federal payments to the plans would be adjusted for risk, which means larger subsidies for plans enrolling sicker patients. Moreover, those payments would rise every year to reflect the actual cost of providing care to Medicare patients. That would avoid the problems Medicare has experienced with payments now pegged to some artificial inflation rate, which can result in underfunding and a loss of access to healthcare services.
If traditional Medicare is a more expensive plan that attracts sicker patients, those safeguards would substantially moderate premium increases. But if traditional Medicare is more effective in controlling health costs, as some claim, then beneficiaries in that program could see their premiums decline under the premium support provision.
The premium support provision in the House bill would be introduced in a carefully measured way, but it could still lead to risk-selection problems. Any such problems that did arise would develop over a period of years, allowing more than enough time for the Medicare administrator or Congress to take action to protect beneficiaries. That might be small comfort to the supporters of the status quo, however. After all, Congress has taken fourteen years (and counting) to develop an acceptable prescription drug benefit since its last foray into this issue, despite clear and growing demands from beneficiaries.
Taken on its own terms, the premium support provision is a step in the right direction. A new approach is needed if we hope to control Medicare costs over the long term. The traditional Medicare program is an uncapped entitlement to payment for healthcare providers. Payment incentives foster ever-expanding spending growth for services that, at the margin, are not worth what they cost. Premium support would change those incentives by placing traditional Medicare and private plans on a more even footing, one that would penalize waste and inefficiency. But the House provision is embedded in a highly regulatory structure that will limit the plan choices beneficiaries can have. Congress can do better.
Problem 4: Competition will not work under the weight of over-regulation and micromanagement.
Critics argue that the failure of the Medicare+Choice program proves that competition among health plans cannot work in Medicare. In one important sense, the critics are correct. If Congress imposes too many restrictions on how plans may operate and compounds that handicap with unrealistic payments that do not keep pace with the cost of care, the health plans will drop out. A poorly designed system that does not give competition a chance will ultimately fail.
One of the most troublesome restrictions in the proposals limits the number of PPOs that may operate in each geographic region. Under both bills, the three lowest “credible” bids are given government contracts, and other “credible” bidders are excluded. A “credible” bid presumably means that the benefits, cost sharing, and customer service that the plan proposes seem reasonable to the government bureaucrat in charge of this process. Eliminating plans that bid high assures a larger market share for winning plans. Such a guarantee is necessary to overcome the reluctance of health plans to venture into this new Medicare program, which would require PPOs to expand into less profitable rural markets. But that would also eliminate some plan choices that might be attractive to a significant number of beneficiaries.
Rather than empowering bureaucrats, Congress should empower consumers. Both bills require beneficiaries to pay the full additional cost of a more expensive health plan through higher premiums. Seniors have a well-deserved reputation for scrutinizing their healthcare costs. We can count on them to seek the best value, which for many (but not all) will be the lowest cost plans.
Eliminating the three-low-bidder requirement begins to unravel the complicated web of provisions in the proposals, and other changes would be necessary. The legislation should eliminate provisions that create unnecessary impediments to health plan participation in Medicare.
Solid private health plans, including employer health plans, would be more likely to enter a competitive Medicare program if they could do so without having to fundamentally change the way they operate. Such plans could be permitted to define their own benefits, cost-sharing requirements, provider networks, and geographic market areas, as long as they meet basic solvency and consumer protection requirements. It should not be necessary to herd people into special Medicare-only plans just because they have had their sixty-fifth birthday.
Many of the restrictions in the current proposals are intended to give rural beneficiaries a choice of private health plans. This is a perverse kind of cross-subsidy: Congress would create limited plan options in rural areas by hobbling competition in more populous markets where most of Medicare’s money is spent. By requiring PPOs to operate in large, multistate regions and limiting the number of successful bidders, the federal government would overpay PPOs in their established urban markets. The extra money would compensate the plans for the high fees demanded by rural providers and other costs of expanding into new markets.
In essence, the current proposals subsidize urban health plans in the hope that seniors in rural areas would benefit. It would be far more efficient and effective to subsidize rural beneficiaries directly rather than imposing complicated mandates on private health plans that would reduce competition and consumer choice for the majority of seniors.
Congress has a second chance to design a competitive Medicare program that will work, but it must build into the current proposals more flexibility for health plans and beneficiaries alike. Restrictions on the number and types of plans that may compete in Medicare, and on the way those plans design and manage the benefit, should be relaxed. The government should work hard to overcome its well-deserved reputation as a bad business partner by reducing administrative burden and opening lines of communication. And the government should shed the conceit that it can control a complex and inherently unpredictable health system by the application of more and better laws and regulations.
An Unprecedented Opportunity
The focus on private health plans, complicated bidding arrangements, and the myriad of technical adjustments in the proposals sometimes obscures what Medicare reform is really about. The two main objectives of reform should be to make Medicare a better program for America’s seniors and a more affordable program for everyone. Congress has an unprecedented opportunity to promote better health outcomes, reduce unnecessary spending, and give consumers more control--and more personal responsibility--over their healthcare. Congress can start us down that road this year, but only if the Medicare legislation that emerges from conference avoids the mistakes of the past.
The conference committee could take three actions that would change the terms of debate and break the political impasse. First, conferees must build flexibility into the reform and preserve options (including traditional Medicare) for beneficiaries. Excessive regulation and complexity would stifle innovation and unnecessarily limit health plan choices. A more flexible approach modeled after the FEHBP would more effectively encourage plan participation than the current proposals, and would offer more choice and better consumer protection for seniors.
Second, the committee should take full advantage of clinical research, information technology, and insurance innovation. The reform should build toward an information-intensive future that can improve quality of care and consumer satisfaction, and reduce costs.
Third, conferees need to make Medicare work for the sickest patients. People with multiple chronic illnesses account for the bulk of Medicare spending, but the traditional Medicare program does nothing to coordinate the services they receive. That often means inappropriate care, excessive cost, and worse patient outcomes than could be achieved if Medicare’s resources were managed more intelligently. A prescription drug benefit is the missing piece that will make patient management strategies possible in traditional Medicare if Congress thinks creatively.
None of these ideas resolves the premium support controversy. The conference will seek a compromise, perhaps testing premium support in several market areas in 2007 or 2008 after the drug benefit has been firmly established. That makes sense if the final bill adopts only portions of the FEHBP model, which at this juncture seems likely. Testing would reveal where problems lay and would give all parties a chance to make premium support work under less-than-ideal conditions.
Congress will likely serve up half a loaf of Medicare reform: allowing more competition among private plans immediately, but delaying competition among all the plans (including traditional Medicare) for a decade or more. That will be a success if the legislation creates a framework that can support additional reform in a few years, when the reality of runaway Medicare spending begins to hit home. But such a success will require strong political leadership and major changes in the legislation now in conference
Joseph Antos is the Wilson H. Taylor Scholar at AEI.
