Privatizing Medicare

Medicare’s ability to pay lower fees is due to its size. With 36 million people, traditional Medicare is far and away the nation’s largest insurance program. It’s so big and provides such a large portion of the average provider’s revenues that providers can’t afford to walk away from the Medicare population. 

When we add HMOs’ higher overhead (20 percent) to their fee disadvantage (20 percent), we’re looking at a handicap equal to roughly 40 percent. HMOs have only two ways to offset this enormous handicap: (1) they can deny much more medical care to their patients than traditional Medicare denies its patients; (2) they can seek to avoid the sickest patients and enroll only the healthy. Neither strategy is morally or politically acceptable. 

The HMO industry’s efforts to ration health care in the nonelderly market backfired so badly in the mid-1990s that the industry has begun to back away from its most aggressive managed-care tactics. If the nation wouldn’t tolerate aggressive rationing by HMOs among the nonelderly, it would certainly not tolerate even more aggressive rationing among the elderly. 

That leaves the HMOs with only one strategy: to enroll only the healthiest seniors—a tactic called cherry picking—but get paid as if they were enrolling average seniors. At least two dozen studies have demonstrated that HMOs have benefited from this strategy for at least the last two decades. Congress has been apprised repeatedly of this fact. The U.S. General Accounting Office (GAO), the Congressional Budget Office, and the Medicare Payment Advisory Commission have all sent reports to Congress stating that Medicare is overpaying Medicare HMOs by large amounts because the HMOs attract disproportionately healthy seniors. The GAO reported in 1999, for example, “studies conducted by us, ...the Medicare Payment Advisory Commission...and others demonstrated that the Medicare program spent more on beneficiaries enrolled in health plans than it would have if the same individuals had been in  [traditional Medicare]. This unexpected result occurred because Medicare  payments were based on the estimated cost of... beneficiaries [in traditional Medi- care] in average health and were not adequately adjusted to reflect the fact that plans tended to enroll beneficiaries with better- than- average health....” 

The studies the GAO cited indicate the Medicare overpayment to HMOs lies somewhere in the range of 15 to 45 percent. If this seems hard to believe, consider just one of the studies the GAO was referring to—a study by the Physician Payment Review Commission, a predecessor to the Medicare Payment Advisory Commission. In its 1996 report to Congress, this commission reported a study it had done which found that the seniors who enrolled in Medicare HMOs were so healthy they cost the HMOs only 60 percent of the average cost of Medicare beneficiaries. 

If we tack on another type of overpayment—this one equal to about 5 percent of Medicare payments to HMOs—caused by HMOs fraudulently inflating their administrative costs, a problem documented by a 1998 report of the Department of Health and Human Services, we may say Medicare has been overpaying the average HMO by somewhere in the range of 20 to 50 percent. It is this gigantic, unintended overpayment that makes it possible for some HMOs to survive in the Medicare “market” despite big handicaps—high overhead and relatively high provider payments. 

Medicare HMOs may continue forever to get away with inflating their administrative costs and inducing Medicare to pay it (the Clinton administration showed, and the Bush administration has so far shown, no interest in preventing HMOs from padding their Medicare charges), but they can’t continue forever to cherry pick. Enrolling the healthiest of the Medi- care population is possible only as long as the HMOs enroll a tiny proportion of that population. If and when HMOs begin to enroll a growing proportion of the Medicare population, which is the Republicans’ goal, HMOs will find it more and more difficult to avoid their share of the sick. As the HMO industry’s share of Medicare beneficiaries rises from its current level of 11 percent, and as the typical HMO enrollee becomes more typical of the Medicare population, the unintended cherry-picking subsidy to the HMOs will vanish. 

HMOs start out with two financial disadvantages against traditional Medicare: (1) they generate administrative costs equal to roughly 20 percent of their revenues; (2) they pay higher provider fees equal to about another 20 percent. It’s conceivable that a pro-HMO Congress could eliminate the latter handicap by simply ordering providers to charge Medicare HMOs no more than they charge the traditional Medical program. But even if Congress would do that over the objections of the physicians, hospitals, and (if drug coverage is added to Medicare) the drug companies, the HMO overhead problem would still remain. The HMOs’ two remaining weapons—rationing and cherry picking—will be nowhere near potent enough to offset their overheads. Aggressive rationing of Medicare beneficiaries by HMOs is not politically and morally acceptable, and the HMO cherry-picking advantage will disappear as privatization gradually brings a larger and larger portion of the Medicare population into HMOs. 

Privatization cannot save Medicare money. Republicans should drop their privatization proposal and kick the HMOs out of Medi- care all together.