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Understanding the Effects of Major Medicare Savings


Most of the attention on the proposed changes in Medicare has focused either on the overall size of the spending reductions or on what will happen to the Part B premium. Since these issues can be translated into simple dollar differences, it is then tempting to suggest that all that is needed for compromise is to "split the difference" in the numbers. But the proposals of the Congress and the Clinton Administration differ on much more than the dollar magnitude of the changes. Key structural differences between the proposals need to be understood as well.

The Balanced Budget Act of 1995, which contained a comprehensive set of changes in the Medicare program developed by Congressional Republicans, sought to reduce Medicare spending by $226 billion over seven years. This would include a number of important structural changes that differ from current law and signal a new direction for policy for Medicare. Overall, the Congressional approach to reform would stress moving Medicare beneficiaries into private plans of various types. While there has long been an option under Medicare to allow beneficiaries to enroll in health maintenance organizations (HMOs), the proposed legislation developed by the Congress would seek to expand the opportunities for the private sector to offer new types of plans and to change the way in which these plans would be paid and how they would interact with the traditional part of the Medicare program.

How does the Congressional proposal for Medicare found in the Balanced Budget Act seek to achieve savings? On the traditional fee-for-service side of the equation, proposed changes continue to rely upon restricting payments to the providers of services and less directly imposing limits on the use of services. Altogether, these changes would generate about two thirds of all the savings in the legislation. Limits on payments to health maintenance organizations and other private plans that enter this new market will be constrained with specific growth targets—growing an average of about 5.1 percent per year per capita through 2002 and a steady 5 per cent per year after that. And a new "failsafe mechanism" would penalize providers on the fee-for-service side of Medicare if growth rates exceed overall targets for the program—thus placing additional pressures on providers to limit the use of services. Overall, Medicare program payments would be allowed to grow at just 5.7 percent per year on a per capita basis as compared to a projected 7.9 percent growth rate if no policies change over the period.

The Administration's proposal, in contrast, would both generate more limited savings of $97 billion and would reform managed care options on a more incremental basis. Premiums would be raised to a much more limited degree, and a number of key changes contained in the Republican proposal would not be allowed. The rate of growth of Medicare would fall from the 7.9 percent projected for the future with no policy changes to 6.4 percent—an amount considerably less than the Republican proposal, but still a substantial decrease. Moreover, this amount is lower than the 7 percent per year projected for private insurance plans over the next seven years and lower than that achieved either by Medicare or private insurance over the last seven years.

In addition to these differences in the overall magnitude of savings, the Administration and Congressional approaches differ in terms of how the program would change. Key structural reforms have been proposed by the Congressional Republicans. One important overarching thematic difference between the approaches can be found in attitudes toward oversight and control over the Medicare program. Across a broad array of elements of the program, the Congressional approach would relax limitations and restrictions on offerings of comprehensive private plans, allowing beneficiaries more choice and more exposure to both the benefits and vagaries of the private market. The Administration's changes are more incremental in nature and would retain tighter control, particularly over the expansion of private options for managed care contracts.

In addition, five key issues highlight how the Balanced Budget Act would affect Medicare. The first of these reflects a problem common both to the current system and to any proposal for retaining or expanding comprehensive private alternatives to Medicare—the issue of risk selection. If private plans can attract healthier than average patients, they can benefit at the expense of the Medicare program. Although risk selection is a problem that plagues any solution, by opening Medicare to many different types of private plans, such as medical savings accounts and association plans, the Balanced Budget Act may exacerbate the problem.

Second, a new failsafe mechanism could further de-stabilize the Medicare program. Under this new mechanism, if annual spending targets for Medicare are exceeded, the fee-for-service side of Medicare would be penalized. And this penalty would apply even if the problem in holding down spending growth arises from healthier beneficiaries enrolling in private plans and leaving the sickest patients to be cared for in traditional Medicare. Thus, if risk selection is a problem, the failsafe will penalize fee-for-service Medicare for caring for the sickest beneficiaries.

A third issue arises over whether Medicare is moving from a program that guarantees a specific level of benefits to one which assures only a dollar contribution towards the costs of such benefits. The current system for establishing premium contributions for private plan options—and that which would be retained by the Administration—ties payments to the fee-for-service side of Medicare. This is likely to result in payments that are higher than desirable to achieve savings. The Congressional approach to this problem would be to set an arbitrary limit on the growth in payments over time. While it would break the link to fee-for-service, it means that there would no longer be a promise that the contributions from Medicare would be sufficient to cover the costs of providing care, changing the guarantee from that of a defined benefit to that of only a defined contribution. Further, the Congressional approach would allow plans more latitude in charging premiums from beneficiaries.

Both the Congressional and Administration proposals to reduce geographic differences in payment levels for private plans need more careful study since they may generate some unintended consequences. Payment rates for private plans could rise much faster—or slower—than average in some areas of the country, both in comparison to other areas and in comparison to payment levels offered to traditional fee-for-service Medicare providers in a given area. This may lead to unfair advantages for some plans or providers.
Finally, opportunities for greater beneficiary burdens over time arise from several of the proposed changes in the Balanced Budget Act. While much of the attention in the media focused on differences in premium increases proposed, other structural changes in the Balanced Budget Act could also have important effects on costs to beneficiaries. In particular, some private plans could allow physicians to bill patients for amounts over and above fees deemed reasonable by the plans. Many beneficiaries might not understand this provision when choosing among plans. Further, private plans would have more latitude for establishing additional premiums for private MedicarePlus plans under the Balanced Budget Act and perhaps more incentive to do so when faced with strict limits on the growth in the amount that Medicare pays on behalf of enrollees.

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Understanding the Effects of Major Medicare Savings, Marilyn Moon, The Commonwealth Fund, March 1996