On Reforming Medicare

Policy Backgrounders | Health

No. 151
Friday, February 04, 2000
by John Hoff

The Current Structure of Medicare

Even though the financing of current Medicare benefits is unstable and raises critical budgetary issues, some people are demanding additional benefits. Medicare only covers nursing home care for 100 days after a hospitalization, limits the number of covered hospital days and covers few outpatient prescription drugs. Medicare covers care for illness, not management of chronic conditions. To some people, reform means adding these benefits to Medicare coverage. In addition, the president proposes expanding Medicare to cover unemployed individuals as young as 55 on what he alleges would be a cost-neutral basis to Medicare.

Medicare in its current form not only is rife with waste and inefficiency, but also leaves beneficiaries exposed to thousands of dollars in out-of-pocket costs. As many as 360,000 Medicare beneficiaries faced annual costs in excess of $5,000 each in 1998.2

  • To avoid the prospects of financial devastation, a majority of seniors acquire private insurance to fill the gaps in Medicare - either through a former employer (30 percent), private "Medigap" insurance (28 percent) or a combination of the two (4 percent).3
  • However, economic studies show that seniors with supplemental insurance consume significantly more health care than those without the insurance.4
  • In addition, most Medigap policies do not cover drugs and many employer plans have incomplete coverage.

"Some 16 percent of Medicare beneficiaries have joined managed care plans."

Medicare was formulated in the 1960s and modeled on the fee-for-service private insurance of that era. While the commercial market has since developed a variety of insurance and delivery arrangements, and medicine has advanced tremendously, Medicare has remained much the same. Approximately 84 percent of Medicare beneficiaries are in the fee-for-service system. Medicare pays providers for each service, so Medicare and its contractors must determine the reasonableness and necessity of millions of services each year. At the same time, Medicare permits patients to demand any service they hope may help them, regardless of its merit or cost, and physicians have an economic incentive and professional imperative to satisfy these demands. They are subject only to Medicare's finding a particular service unnecessary and refusing to pay.

Medicare has sought to counteract these incentives by setting the prices it pays hospitals, doctors and other providers. The result is a complex scheme that sets the amount Medicare pays for virtually every service provided to every Medicare beneficiary. Of course, no bureaucracy can determine the "right" price for every service. To the extent that the price is higher than it would be in a competitive market, Medicare money is wasted. To the extent that it is lower, providers must subsidize Medicare beneficiaries and thus find it more advantageous to concentrate on private pay or private sector patients.

Medicare controls beget additional controls, making the system's rules and restrictions even more incomprehensible and difficult to follow.

To keep patients and providers from circumventing the controls, the Health Care Financing Administration (HCFA), the agency that administers Medicare, has sought to prohibit beneficiaries from using their own money for care that Medicare does not cover or determines is not medically necessary. A recent court decision permits beneficiaries to obtain such care, but only if the doctor and patient engage in a bureaucratic process of red tape. Overall under Medicare, patients are prohibited from paying out of their own pocket to obtain care from a physician of their choice, unless the physician is willing to undergo severe penalties (i.e., exclusion from the Medicare program for two years).

"No one has an incentive to balance the cost of care against the expected benefit."

As a result of these controls, Medicare has changed from a program that helps beneficiaries pay for care they and their doctor choose to a government-run health care system that determines what care beneficiaries can get and what prices providers will be paid. Even with these controls and a complex administrative system to review the medical necessity of each specific service, Medicare can control only unit prices, not utilization. Neither patients nor doctors have an economic incentive to balance the cost of care against the expected benefit. And taxpayers, through Medicare, pay.

Some 16 percent of Medicare beneficiaries have joined managed care plans. These plans compete with the open-ended but regulated fee-for-service system and are paid an amount based on the cost of the fee-for-service system, with formulaic adjustments determined by Congress.

Currently, the small percentage of Medicare beneficiaries enrolled in private HMOs get more benefits at a lower cost. However, because the government's method of paying premiums to these private plans is highly imperfect, discrepancies exist. Many believe that the average HMO is overpaid.5 However, a number have been underpaid - and are leaving the market. The plans providing services under Medicare+Choice are subject to a complex and prescriptive regulatory structure, where reimbursements, eligibility and core benefits are all predetermined by the federal government.

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