The Magazine

The Train Wreck Ahead

Medicare is rolling toward disaster, and there is no easy way to fix it.

Jun 16, 2008, Vol. 13, No. 38 • By JAMES C. CAPRETTA
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Medicare's important influence on how health care services are delivered is often overlooked or understated. Medicare is the largest purchaser of services in most markets today. Four out of five enrollees are in the traditional program, which is fee-for-service insurance. That means Medicare pays a preset rate to any provider for any service rendered to a program enrollee, with essentially no questions asked. Nearly all Medicare beneficiaries also have supplemental insurance, from their former employers or purchased in the Medigap market. With this additional coverage, they pay no charges at the point of service because the combined insurance pays 100 percent of the cost. This kind of first-dollar coverage provides a powerful incentive for beneficiaries to use as many services as their physicians suggest might help improve their health. Whole segments of the U.S. medical industry have been built around the incentives embedded in these arrangements. To be sure, Medicare's payment rates are low, but political pressure ensures they are just high enough to protect the status quo and allow doctors, hospitals, labs, and outpatient clinics to continue operating autonomously, each with its own paperwork and billing arrangements, thus underwriting continued fragmentation.

No one is suggesting turning the clock back to pre-Medicare America in order to control costs. Rather, what is needed is a sensible reform for the program that retains security for seniors even as it fundamentally alters the financial incentives in the marketplace to improve the efficiency of health care service provision.

The outline of such a reform has been clear for some time (indeed it was proposed by a largely forgotten Medicare Commission in the late 1990s, chaired by former senator John Breaux and former congressman Bill Thomas). The Medicare entitlement would be converted into a limited government contribution toward insurance, offered by private plans or the government. The government contribution would be set at a predetermined percentage of the average cost of an insurance plan in the area. Enrollees would be free to select whatever plan they found most attractive, including a public option, but if they selected a plan that was more expensive than the average, they would have to pay the additional premium themselves. This type of reform could be phased in, applied to new Medicare entrants so as to avoid disruption for those settled in their current arrangements.

This redesigned Medicare would look a lot like the new drug benefit, now in its third year. By any measure, the drug program's competitive features are working well to keep costs down for enrollees as well as the government, and the vast majority of beneficiaries like the program and the choices it has made available.

Would such a reform bring Medicare spending growth quickly into line with the economy? Official estimates during consideration of the reform or even during the first years of implementation are unlikely to reflect significant improvement from today's gloomy outlook. The dynamic possibilities of the marketplace are real, but quantifying the benefits beforehand is more a matter of judgment than data analysis. Policymakers should not give more weight to such estimates than they deserve. In a market with strong price competition, insurers who found ways to work with more efficient and higher quality provider networks could gain market share with lower premiums. Beneficiaries would also likely enroll in more managed-care settings if they saw lower premiums as a result. In time, these incentives would force real changes in the way services are delivered to patients. And when that happened, the power of compounding would begin to work in the direction of improved solvency instead of looming financial disaster.

No one should be under the illusion that reducing the size of Medicare's financial imbalance could be done without controversy or financial sacrifice, which is why it is not high on the political agenda. But sooner or later Congress will have to tackle the problem anyway. A reform that promotes consumer choice and strong price competition, much like today's drug benefit, has the potential to significantly improve the program's financial outlook and limit the scope of other changes that might be needed (like means testing or a delayed eligibility age). But if Congress is unwilling to rely on the marketplace to weed out inefficiency, for political or other reasons, bringing Medicare spending into line with what is affordable over the long-run will be unpleasant work indeed.

James C. Capretta is a fellow at the Ethics and Public Policy Center and a consultant to private health insurers.