NCPA - National Center for Policy Analysis

The Medicare Auction Design and Incentives for Research and Development

December 1, 2011

Because government health programs -- Medicare and Medicaid in particular -- use auctions for the acquisition of medical equipment and devices, the incentive on the part of government to seek the lowest possible price is likely to shape the design of the auctions.  Specifically, the government can, through careful design of its auctions, obtain prices far lower than their competitive rate, says Benjamin Zycher, a senior fellow with the Pacific Research Institute.

  • Data show that in 2009 total national expenditures on durable medical equipment was $34.9 billion, of which $10.4 billion, or 29.9 percent, was paid by federal, non-defense programs.
  • The Centers for Medicare and Medicaid Services (CMS) projects that the federal non-defense market share for durable medical equipment will rise from about 32.3 percent in 2011 to about 39.0 percent in 2019.
  • Though the economic literature on the effects of the CMS auction design yields a range of predicted effects in terms of price suppression, the lowest such finding is 33.4 percent.

This governmental bias is likely to yield the delivery of goods and services lower in quantity and/or quality (or effectiveness) than otherwise would be the case.  Additionally, and perhaps more crucially, a reduction in incentives for investment in research and development (R&D) can significantly affect patient wellbeing and aggregate life expectancy.

  • The aggregate projected adverse investment effect is about $2.1 billion in 2011, rising to about $3.1 billion in 2020, or about 12 to 15 percent.
  • Investment growth between 2010 and 2020 falls from 2.24 percent annually to 0.8 percent annually.
  • The scholarly literature on the returns to investment in medical technologies suggests that R&D investment in new and improved pharmaceuticals yields, roughly, an increase of an expected life-year for each investment of about $2,000.
  • If we assume that the CMS auction system reduces investment by (very conservatively) $1 billion per year, the loss in expected life years would be about 500,000 annually.

The government, in attempting to take advantage of prices far below their competitive rate, is inadvertently imposing substantial, long-run costs on society.  As the expected return on new medical technologies decreases, entrepreneurs invest less in the field and fewer breakthroughs are had.

Source: Benjamin Zycher, "The Medicare Auction Design and Incentives for Research and Development," Pacific Research Institute, November 2011.

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