NCPA - National Center for Policy Analysis

Rethinking the Mathematics of Medicare

September 18, 2001

Medicare purchases health care services from physicians, hospitals and other providers for its 39 million beneficiaries covered through traditional fee-for-service (FFS) medicine and managed care plans such as health maintenance organizations (HMO). Although the rules governing Medicare premiums are set nationally, the county of residence of the beneficiary often determines the level of benefits provided. For example:

  • The HMO payment rate in Miami is nearly twice the Minneapolis-St. Paul, Minn., rate.
  • The rates for HMOs in Miami, Fla., allow them to waive coinsurance and deductibles.
  • Prescriptions drugs are often covered in Miami.

Rates paid to HMOs are based, in part, on regional FFS spending levels. However, HMO rates do not vary as much as the FFS spending, making HMO reimbursements in some regions more generous than in others.

Twin Cities HMOs are penalized by the apparent success of local FFS providers in holding down costs. This has led some researchers, including Bryan Dowd from the University of Minnesota, to propose methods to introduce competition into Medicare. Rather than the government offering to pay a fixed rate in a region, the health plans would disclose what it costs them to provide Medicare services. Then,

  • Medicare would pay a benefit package equal to the lowest priced plan.
  • Higher priced plans would have to collect an out of pocket premium from Medicare beneficiaries equal to the difference between their costs and the lowest cost plan.
  • A $10 difference in out-of-pocket costs between two health plans would result in an estimated 4 to 6 percent reduction in the higher-priced plan's market share.

These adjustments would give firms an incentive to compete on price rather than richness of benefits. It would also prevent Medicare HMOs from being rewarded for the inefficiency of FFS providers within a region. In 1995 the government planned a demonstration project to test some of these theories. But six years later the plans still have not implemented due to political interference from health plans.

Source: "Rethinking the Mathematics of Medicare," Health Services Research and Policy, Division News, School of Public Health, University of Minnesota, Summer 2001.


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