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Testimony Before the Senate Finance Committee

Comparing the Traditional Medicare Program to Private Insurance

May 12, 1999

am here today to discuss with you the differences between the traditional Medicare program and private insurance. The latter includes insurance products that are obtained through public purchasers, such as the Federal Employees Health Benefits Program (FEHBP) and the California Public Employee Retirement System (CALPERS). I draw heavily on my work with three organizations: the Center for Studying Health System Change (HSC), where I serve as president; the Study Panel on Fee-for-Service Medicare sponsored by the National Academy of Social Insurance (NASI), which I chaired; and the former Physician Payment Review Commission, where I served as executive director.

When the Medicare program was designed and implemented in the 1960s, many aspects of it were modeled after the leading private insurance plans. But the two have diverged over time. Medicare, which has had the market power to pay providers on the basis of administered prices, developed sophisticated mechanisms to determine payment rates for different classes of providers. Some elements of the administered pricing systems were oriented towards influencing the delivery of care, for example the encouragement of shorter hospital stays. Private insurers, which had less market power, developed mechanisms to purchase services competitively through limiting provider panels and an array of administrative tools to influence how care is delivered. I refer to these tools as "care management."

Provider Payment

Although Medicare initially paid providers on a passive basis-what hospitals costs were and what other providers generally charged-it developed more aggressive systems over time. Medicare developed hospital prospective payment and a physician fee schedule in order to pay less than under the passive payment systems and to provide some incentives for more cost conscious delivery of care. The overall level of payment has been influenced greatly by Congress’ desire to reduce the federal budget deficit. Thus, substantial payment cuts were enacted as parts of various budget reconciliation bills throughout the 1980s and 1990s. In this process, interests of providers compete politically with interests of beneficiaries, the interests of groups benefiting from other federal spending, and the interests of taxpayers. My observation has been that overall federal budget policy has been a much more important driver of these changes than the anticipated shortfall of the Medicare trust fund.

Medicare has also successfully used its administrative pricing system to change provider incentives. Thus, paying hospitals on a per admission basis provided incentives to shorten lengths of stays. The physician fee schedule shifted physician incentives away from the provision of medical and surgical procedures towards the provision of evaluation and management services.

Often at the behest of employers, private insurers have evolved their provider payment mechanisms in the direction of competitive purchasing. By establishing networks of hospitals, physicians, and other providers that enrollees could access with less out-of-pocket expense, private plans have been able to negotiate payment rates with providers. The stronger the ability of the plan to influence the choice of providers by its enrollees, the greater the price concessions that it is able to achieve. Thus, HMO products often pay providers at lower rates than preferred provider organization (PPO) products.

Private insurers have also used payment mechanisms designed to influence how care is delivered, mostly in HMO and point of service (POS) products. For example, primary care physicians are often paid on the basis of capitation for primary care services-that is, a fixed amount per enrollee per month. An HSC physician survey shows that 72 percent of primary care physicians are in practices that accept capitation and for those with some capitation, it accounts for 32 percent of practice revenue. Bonuses are often paid to physicians whose patients are most satisfied with their care. Less common, but seen as a cutting edge practice, a capitated payment for all services (referred to as "global capitation") is negotiated with an organization that includes hospitals and physicians.

Private insurers now typically use the Medicare fee schedule as a benchmark in physician payment. Thus, the conversion factor may be higher or lower than used by Medicare in the area, but the relative values are the same. Private insurers tend not to use per case payment of hospital care, preferring instead to use administrative controls to limit lengths of stay.

Care Management

Private insurers have done much more than Medicare in the use of administrative mechanisms to influence how care is delivered. For example, private insurers routinely require authorization for hospital admissions. Although such requirements originated in managed care products, they are now common in traditional plans as well. In many cases, authorizations are required for major procedures as well, such as MRI or CAT scans. Managed care plans often require enrollees to see a primary care physician for referral to a specialist. HSC data show that in 1997, 46 percent of persons with private insurance had such a "gatekeeper" requirement. In some plans, the primary care physician must obtain an authorization to make a referral. Financial incentives to primary care physicians are also used to limit referrals to specialists. None of these tools are used extensively in Medicare.

These care management mechanisms are not used as frequently by health plans when providers are "at risk" for spending. In the extreme, where providers are paid on the basis of "global" capitation, the responsibility for limiting care is transferred from the health plan to the provider organization. The plan’s activities dealing with care delivery are limited to monitoring quality. In intermediate situations, such as contracting with a provider on the the basis of an episode of care, such as for coronary artery bypass graft surgery (CABG), the plan’s only role might be in approving the procedure, with the balance delegated to the provider of services. Through a demonstration project, Medicare is also experimenting with episode-based payment for CABG.

Managed care is in a period of widespread experimentation with respect to influencing the delivery of care. Much is being done in the area of prevention. Health plans send reminders to enrollees to schedule appointments for preventive services, such as mammograms.

The most innovative plans identify persons with certain chronic diseases, such as diabetes, and prescribe a regimen of preventive services, education, and self care. Often referred to as "disease management," secondary prevention activities have also been applied to asthma and congestive heart failure. Some insurers have developed or disseminated practice guidelines to physicians to help them practice in a manner that research has shown to be most effective. Some have used data on physician practice patterns to limit their networks to those practitioners who practice more efficiently. Some have programs of high-cost case management, in which extra benefits, such as modifications to the patient’s home, can be provided to improve outcomes or lower costs. But other plans have focused exclusively on obtaining discounted payment rates from providers and have not invested in these care management mechanisms.

Many of these mechanisms are still evolving and must be considered "experimental." Although few have a research literature to vouch for their cost effectiveness, the fact that use of these tools is becoming widespread is an indication that plans-and in some cases, employers-believe that they are worthwhile and may become more effective in the future.

Constraints Facing Medicare Program

Why has Medicare done less in the areas of selective contracting with providers and administrative tools for care management? Two key reasons come to mind. First, government programs operate according to different rules than private enterprises. These rules limit flexibility and make changes slower. Second, in many areas, Medicare beneficiaries have few, if any, alternatives to the traditional Medicare program. The inability of beneficiaries unhappy with a practice to go elsewhere leaves the traditional plan with the responsibility to attempt to meet the needs of all beneficiaries.

The size of the Medicare program, in conjunction with its status as a government program, limits its ability to interact with providers in various ways. Since the program is so important to hospitals and to physicians in certain specialties, political constraints bar it from excluding from the program a provider who, while not committing fraud, has a highly inefficient practice style. Because Medicare payment rates are so critical to providers, they are decided through a political process in which the welfare of providers is weighed against the needs of taxpayers and beneficiaries. On a number of occasions, Medicare demonstrations of a new payment mechanism have been blocked by lobbying of constituencies that might lose out.

The process of government also makes it difficult for Medicare to pursue innovations in payment or care management. Since society is reluctant to allow government officials the level of discretion that managers of private entities enjoy, procedures to make decisions are cumbersome and time consuming. Government officials must demonstrate the rationale for their decisions and must provide affected parties an opportunity to express their concerns. Sunshine laws restrict the ability of government officials to negotiate with providers behind closed doors in the manner that their private plan counterparts are able to.

The report of the NASI panel that I chaired described particular problems experienced by HCFA with innovations tested in demonstrations. When demonstrations are successful, it lacks the authority to implement the tools widely. When demonstrations are not successful, political constraints sometimes make it difficult to stop them.

Medicare faces an additional problem that results from the way in which the Congress provides the funds for the program. As an entitlement program, funds to pay providers are not subject to the appropriations process. But the funds to administer the program are and Medicare’s administrative needs must compete with more glamorous activities, such as biomedical research. The result has been that Medicare has long underinvested in administrative activities and cannot afford many of the care management activities described above, even when there is an expectation of substantial savings in benefit payments.

The lack of choice of program by many beneficiaries constrains the program in many ways. It means that mechanisms that restrict beneficiaries cannot be implemented except on a volunteer basis. For example, if a gatekeeping requirement were added, those who value direct access to specialists would feel a significant loss. A private plan could include such a requirement with the knowledge that those unwilling to deal with it could switch to another (presumably more expensive) plan without such a requirement. This lack of choice means that even if a private organization were retained to administer Medicare on an incentive basis, as has been proposed on a number of occasions in the past, Medicare’s being the sole choice for many would lead to severe constraints on its flexibility.

This may become less constraining over time. With increasing options through Medicare+Choice for plans that resemble what most of the younger population is enrolled in, there may be less need for traditional Medicare to meet the needs of all beneficiaries.

Policy Directions

Congress can pursue two courses to bring additional care management activities into the Medicare program. One is to encourage greater enrollment in private health plans. Congress took some steps in this direction in 1997 when it established the Medicare+Choice program. Under Medicare+Choice, HCFA has the opportunity to further the use of private plans by innovating as a purchaser, but it also must guard against retarding the development through being too interventionist. Proponents of premium support proposals also seek to further encourage enrollment in private plans.

The second course is to take steps to make it easier for the traditional Medicare program to incorporate innovations in care management. The NASI panel developed a series of recommendations to encourage and facilitate innovation in the traditional Medicare program. These included a directive to HCFA to innovate by adapting the best practices of private health plans, authority for HCFA to waive certain statutory requirements in order to experiment and move from demonstrations to implementation like private organizations, and requirements for frequent reporting on how this authority is being used. The panel felt that improving traditional Medicare was compatible with continued development of private health plan options in the program. Its work was in response to forecasts that even if private plans have great success in attracting Medicare beneficiaries from the traditional program, that enrollment in the traditional program would be substantial for many years to come and that beneficiaries and taxpayers should benefit from innovation in management.

In sum, the Medicare structure has led to valuable innovations in provider payment but much less in the way of innovations in care management. The program needs to innovate in order to contain costs and to pursue opportunities to improve the quality of care for beneficiaries. Additional enrollment in private plans and more innovation in the traditional Medicare program are both viable options to accomplish this important and laudable goal.


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