Bad Prescription.

Why privatizing Medicare may be hazardous to your health

When the debate over the fate of Medicare heats up later this spring, you'll hear a familiar battle cry: The retirement of the Baby Boomers is sending Medicare into "bankruptcy" and it can only be "saved" by privatization. This claim is nonsense, but Republicans have been making it ever since they took over Congress in 1995. By the time you read this, the Republican position may have been endorsed by the National Bipartisan Commission on the Future of Medicare, a committee established by Congress to examine the Medicare "crisis." This commission was required to send its recommendations to Congress by March 1. Any recommendation must have the support of a supermajority of 11 of the commission's 17 members. It was clear by January 1999 that the privatization of Medicare had the support of 10 members. At a two-day meeting held January 5 and 6, eight of the commission's Republican appointees and two Democrats indicated their support for privatization.

At stake in the upcoming Medicare debate is not just the fairness and sufficiency of Medicare funding, but whether health care for America's elderly will be turned over to the insurance industry which has made such a mess of health care for the non-elderly. To judge from the privatizers' rhetoric, you would think that health care costs for the non-elderly were under control, that the number of uninsured Americans under 65 was falling, that quality of health care was improving, and that non-elderly Americans were thrilled with the restrictions imposed by the HMOs which have come to dominate the U.S. health care system. But the privatizers have it backwards: Medicare is more effective at controlling health care costs than the private sector is, and Medicare has achieved this level of efficiency without resorting to the private sector's favorite cost-control technique--denying necessary services to patients.

The claim that Medicare is going "bankrupt" is extremely misleading for two reasons. First, it implies that the insurance companies that now insure the non-elderly are more efficient than Medicare. That implication is false. Second, the "bankruptcy" rhetoric obscures a fundamental problem: Medicare draws a substantial portion of its funding from a 2.9 percent payroll tax which is unfair to working people. This tax is unfair because it is regressive (a tax is regressive if it takes a rising percent of income as income falls). If current law governing Medicare remains unchanged, this tax will have to be raised in the near future because the ratio of retirees to workers will increase as the Boomers retire. America should be debating how quickly we can replace the regressive payroll tax with a progressive tax, not how quickly we can privatize Medicare.

It is precisely because Medicare relies for 60 percent of its funding on an earmarked payroll tax that Medicare is vulnerable to bankruptcy rumors. The 2.9 percent payroll tax pays for hospital services provided by Medicare. (The other 40 percent of Medicare funding, which pays for physician services, comes from general revenues and a monthly premium paid by the elderly.) The basis for the claim that Medicare is "going bankrupt" is the projection that revenue from the 2.9 percent payroll tax will drop below Medicare hospital expenditures in 2008, just two years before the leading edge of the Baby Boom turns 65. The projections are accurate. It's the "bankruptcy" rhetoric that's deceptive. If Medicare were funded by general revenues, as most government programs are, it would be more difficult for privatizers to argue that bankruptcy is the inevitable result of forces beyond congressional control. Can you imagine anyone arguing that the Pentagon is "going bankrupt"? Of course not. The Pentagon will "go bankrupt" only if Congress wants it to. The same is true of Medicare. Medicare will expire only if a Republican-controlled Congress says it should.

Republicans have never made their peace with Medicare, a popular program that covers 15 percent of the U.S. population and pays 20 percent of the U.S. health care bill. When Congress enacted Medicare in 1965, a majority of Republicans in Congress voted against it. Today, few Republicans are willing to call for the elimination of Medicare. (Newt Gingrich was an exception. In a speech to Blue Cross Blue Shield executives, he recommended letting Medicare "wither on the vine.") But most Republicans do want to reduce the government's share of health care expenditures for Medicare beneficiaries, and they want private insurance companies to have much more control over Medicare. They know the only way to get Americans to support the privatization of Medicare is to convince us that our choice is between a privatized Medicare and no Medicare at all. Hence the "bankruptcy" rhetoric.

Stealth Plan

Unlike those who seek to privatize Social Security, those who seek to privatize Medicare rarely use the word "privatize," and they do not propose privatization overnight. They propose, rather, changes to Medicare that would render Medicare vulnerable to a gradual takeover by health insurance companies. The privatizers propose to take from seniors Medicare's guarantee of medical services, and to replace that guarantee with a voucher--a set amount of money that seniors could use to buy health insurance, either from traditional Medicare or from HMOs or other types of health insurance companies.

It was this voucher proposal that 10 members of the National Bipartisan Commission on the Future of Medicare endorsed on January 6. Although voucher proponents have not said in so many words that they expect vouchers to force seniors to join HMOs, their high praise for HMOs and other insurance companies that use HMO cost-control tactics indicates that they expect vouchers to have that effect.

On the surface, the voucher proposal seems harmless. Seniors will not be compelled to leave Medicare if they do not want to. If the traditional Medicare program is indeed more efficient than private-sector insurers, then Medicare will offer a more attractive benefit package than the private insurers will, seniors will award their voucher to Medicare, and nothing will change. Or so goes the argument.

But this argument ignores the risk that the voucher experiment will be rigged in the private sector's favor by giving health insurance companies subsidies--subsidies that permit insurance companies to offer lower premiums and/or better coverage than Medicare can. This advantage for the private sector may be further aggravated by setting the value of the vouchers just high enough to cover the cost of buying a (subsidized) private plan, but not high enough to cover the cost of remaining in Medicare. If the difference between the voucher and the cost of staying in Medicare is even a few hundred dollars, a large proportion of seniors would feel irresistable financial pressure to abandon Medicare in favor of the private sector.

How, you may ask, could the insurance industry possibly persuade Congress to fork over subsidies? Wouldn't a request for subsidies destroy the industry's claim that they are more efficient than traditional Medicare? To see how this trick might be accomplished, we need look no further than Medicare's experience with HMOs.

From 1972 until 1998, HMOs were the only type of health insurance company allowed to serve Medicare beneficiaries. But until 1985, very few seniors enrolled in HMOs. That changed in 1985 when the Health Care Financing Administration (HCFA, the agency that administers Medicare) altered the way it reimburses Medicare HMOs. Since 1985, HMOs have been overpaid by HCFA; HMOs have used their subsidies to offer coverage for drugs, hearing aids and other goods and services not covered by Medicare; and, as a consequence, enrollment in Medicare HMOs has soared. Today 17 percent of Medicare eligibles are enrolled in HMOs. Research indicates that seniors did not enroll in HMOs because they enjoy having their choice of doctor limited or because HMOs are known to offer superior or even equivalent health care. Seniors enrolled to get better coverage.

HCFA did not deliberately set the HMO reimbursement rate too high. On the basis of little more than HMO assertions that they were more efficient than Medicare, HCFA set the HMO reimbursement rate 5 percent below the rate at which HCFA reimburses doctors and hospitals in the traditional, fee-for-service Medicare program. But HCFA failed to anticipate that the seniors who would sign up with HMOs would be primarily healthy seniors, and that sicker seniors would refuse to leave classic Medicare. This problem, called "biased selection," is due only in part to the advertising tactics of HMOs (you rarely see someone in a wheelchair in an HMO ad). The more important cause of biased selection in favor of HMOs is the greater reluctance of sicker seniors, as compared to healthier seniors, to give up their freedom to choose their doctors and to run the risk of being denied care. Research on biased selection suggests that Medicare should have set its HMO reimbursement rate as low as 55 percent of the rate it paid fee-for-service doctors (see sidebar), not 95 percent.

HCFA also failed to anticipate that HMOs would be more aggressive at denying health care than doctors paid under Medicare's fee-for-service reimbursement system. A rapidly growing body of evidence indicates that HMO enrollees cost less than Medicare enrollees not just because the former are healthier, but because HMOs deny necessary medical services more frequently than Medicare does. A 1994 study of Medicare patients published in Health Care Financing Review reported that traditional Medicare patients received 18.8 home health care visits during the first 60 days after leaving the hospital compared to 12.7 for HMO patients, and that traditional Medicare patients recovered their health more quickly. A 1996 survey of Medicare beneficiaries conducted for the Physician Payment Review Commission (a congressional advisory committee) found that Medicare eligibles enrolled in HMOs were three times as likely as those in traditional Medicare to report problems getting medical care. A study published in the Journal of the American Medical Association in 1996 found that elderly patients were twice as likely to suffer deterioration in their health over a four-year period (not a decade or a lifetime) if they were enrolled in HMOs than if they were enrolled in traditional fee-for-service health insurance plans. Studies published in JAMA in the summer of 1997 indicated that HMOs perform far fewer cataract operations and provide fewer stroke rehabilitation services to Medicare beneficiaries. On the basis of studies like these, plus an ocean of anecdotal evidence, the October 1996 edition of Consumer Reports urged the nation's Medicare eligibles not to enroll in HMOs "unless money is a very big consideration."

In short, Medicare's experience with HMOs demonstrates how easy it is for HMOs to extract subsidies from HCFA without asking for them--without coming right out and saying, "We're so unattractive that seniors won't join us unless we offer better coverage than traditional Medicare, and, because we're not more efficient than Medicare, we cannot finance the extra coverage unless the taxpayer subsidizes us."

The HMO Shell Game

At this point you might be thinking that the HMO subsidy's days are numbered now that the existence of the subsidy is known. You might be thinking that all these studies documenting biased selection, HMO rationing, and overpayments by Medicare will soon provoke Congress to eliminate the subsidy. If you're thinking that, you're wrong. Although some of the studies documenting the HMO subsidy received extensive publicity when they were released, the subsidy has never been eliminated. Congress did get brave in 1997 and ordered a cut of 2.8 percentage points to be phased in over five years. Beginning in 2002, the average Medicare HMO will be paid 92.2 percent of the average fee-for-service rate.

The HMO industry was not amused. It has just undertaken a national campaign to increase the subsidy. The campaign began last year with a wave of announcements by HMOs that they could no longer afford to offer better coverage to seniors and would be pulling out of the Medicare market. Between the spring and fall of 1998, 43 of the 347 HMOs that served Medicare beneficiaries told HCFA they would not renew their Medicare contracts, and another 54 announced plans to reduce the geographic areas they would serve. On January 1, 1999, over 400,000 Medicare beneficiaries in 29 states and the District of Columbia lost their HMO coverage. Of these, 50,000 have no choice but to return to traditional Medicare and either go without the coverage of drugs and other services they once had, or buy supplemental insurance at a premium far above the premium they paid to their HMO.

The HMOs want the public to believe that HCFA is the villain in this farce. For example, when United HealthCare, the nation's second-largest health insurance company, announced last October that it was abandoning 59,000 Medicare beneficiaries in 12 states, United's chief medical officer explained, "The revenue from HCFA was not high enough..." The news media has obediently passed this rationale on to the public without reminding us of the HMO subsidy. Nor are we being told that doctors in Medicare's fee-for-service sector, who are not getting a handsome subsidy, are continuing to see Medicare patients all over the country including the regions from which Medicare HMOs have pulled out. Only the bloated, heavily subsidized HMOs are taking their marbles and going home.

In a rational world, the existence of the HMO subsidy, and the abandonment of the Medicare market by so many HMOs, would be interpreted as evidence that Medicare's experiment with HMOs has failed--that HMOs are too inefficient to provide health care to the elderly and the disabled and should be ejected from the Medicare program. As Diane Archer of the Medicare Rights Center put it to The New York Times last August, "People seem to forget that Medicare was created because private insurers could not make money on the elderly population." But despite the evidence that HMOs enroll healthier seniors and ration aggressively, and despite evidence that HMOs are incapable of attracting seniors and making money off of them without large subsidies, there is no movement in Congress to kick HMOs out of Medicare. It is more likely that Congress will increase the subsidy, at least for those HMOs that have announced they are bailing out.

The unwillingness of Congress to eliminate the HMO subsidy even after the subsidy has been documented suggests that any experiment with Medicare vouchers will be rigged. In such an experiment, the advantage to the private sector conferred by subsidies may be further enhanced by miserly voucher levels. An example will illustrate. Let us say that Medicare, which now spends about $5,500 per beneficiary, set the voucher level at $5,000 per beneficiary. Let us also say that the private sector, enjoying the advantages of biased selection and/or invisible rationing, can afford to set its premiums at $5,000 whereas traditional Medicare must continue to charge $5,500. Now all but wealthy seniors will have a strong incentive to leave Medicare and enroll with a health insurance company. Sicker seniors who want to stay in traditional Medicare will have to come up with an additional $500 payment.

If the voucher experiment is rigged well enough, that is, if biased selection and rationing permit health insurance companies to create a large gap between their premiums and Medicare's, and if the voucher is not sufficient to cover Medicare's premium, all but the wealthy sick will abandon Medicare. Privatization will have been achieved even though the word "privatization" may never have escaped the lips of its proponents. Proponents will assert that privatization occurred through the "free choice" of millions of seniors "voting with their feet."

What is most galling about the recent debate about Medicare--the "bankruptcy" rhetoric, the lionization of health insurance companies, and the call to substitute vouchers for guaranteed medical services--is the failure of Medicare's defenders and the media to counter the attack on Medicare by Republicans and conservative Democrats. There is nothing wrong with Medicare's basic cost containment methods, certainly nothing so wrong as to warrant the herding of millions of enrollees into inefficient health insurance companies, many of which rely on rationing to control spending. Republican and insurance industry propaganda not withstanding, Medicare has been more successful at keeping its costs down than private-sector insurers have. According to a study by the Urban Institute, the growth rate of Medicare's per capita costs between 1984 and 1993 was below that of the private sector for eight out of those 10 years. In the November/December 1998 edition of the journal Health Affairs, HCFA reported that Medicare's spending per enrollee grew at a slower rate between 1969 and 1997 than the private sector's (10.4 percent annually versus 11.4 percent, respectively). This track record would have been even better if Medicare had not been overpaying doctors, hospitals and HMOs. A recent federal investigation reported that Medicare is overpaying its traditional (fee-for-service) Medicare providers by about 14 percent, due in part to fraud by providers and incompetence on the part of the private-sector insurers that handle claims for Medicare. As I reported above, Medicare is also overpaying HMOs.

Medicare has been able to beat the private sector at cost containment because Medicare has very low overhead costs (Medicare spends a mere 2 percent of its revenues on overhead versus at least 13 to 15 percent for private-sector insurers), and because Medicare reimburses doctors and hospitals at rates below those paid by private-sector insurers. Medicare's overhead is much lower than the private sector's because it does not pay for marketing, utilization review (jargon for unsolicited insurance company advice to doctors about how to take care of patients), obscene salaries, and myriad costs associated with influencing public policy. Moreover, Medicare does not have to make a profit for stockholders.

Yet it's also important to note the cost-control techniques Medicare does not use. Traditional Medicare does not use the techniques so beloved by the private sector that now threaten quality of care--restricting the freedom to choose one's doctor, overturning physician-patient decisions, and exposing doctors to financial incentives to deny care.

The real problem with Medicare is not that it is inefficient but that it relies so heavily on regressive taxes. Medicare's method of financing hospital services--payroll taxes on working people--is regressive and increasingly insufficient as the ratio of retirees to workers rises. The problem with Medicare's method of financing physician services is that a fourth of the financing comes from monthly premiums paid by Medicare enrollees. These premiums are even more regressive than the payroll tax. The upcoming Medicare debate should include a discussion about whether to abandon payroll taxes and premiums in favor of a progressive, general tax.

However, a debate about the fairness of Medicare financing is unlikely in the near term. Judging from the lack of interest in this question shown by the National Bipartisan Commission on the Future of Medicare, it is a good bet that the fairness of Medicare taxes will not be a part of the upcoming debate. It appears, rather, that we will debate vouchers, or, in the lingo of the privatizers on the commission, "premium support." We will debate vouchers despite the evidence that Medicare provides higher quality health care to our elderly and disabled at a lower cost than the nation's insurance industry, and despite the crying need for a debate about whether Medicare should continue to rely on regressive taxes. We will debate vouchers because Republicans and their allies in the insurance industry have managed to fool a substantial portion of the nation's opinion-making elite into thinking that Medicare's problem is a cost-containment problem as opposed to a choice-of-financing problem, and that this problem can be ameliorated if health insurance companies are allowed to guard the Medicare chicken coop.

If the privatizers succeed in fooling a majority in Congress, and if the Medicare voucher experiment is rigged, Medicare will gradually be transformed from the most efficient insurance program in the country into a mere funnel of tax money into insurance company coffers. Classic Medicare will have been starved down to a small program for the very sick or killed off entirely. Those who committed this crime will deny their complicity. They will point their finger at all those seniors who "voted with their feet."

RELATED ARTICLE: Corporate Welfare For HMOs: The Evidence

Since the establishment of Medicare in 1965, the great majority of Medicare beneficiaries have been treated by doctors who were paid a fee for each service they rendered. This reimbursement method is called "fee-for-service," and is to be distinguished from the two other common methods of paying doctors--salary and capitation. Capitation refers to a method of paying a doctor a set fee per patient per year.

Between 1985 and 1998, HCFA's reimbursement rate for HMOs was set at 95 percent of the cost of serving an enrollee in Medicare's fee-for-service (FFS) sector. The rate will fall gradually to 92.2 percent by 2002. In setting these rates, HCFA failed to account adequately for the fact that seniors who elect to enroll in an HMO are much healthier than those who choose to stay in traditional FFS Medicare. The tendency of an insurance company, or an entire category of insurers such as HMOs, to attract healthier enrollees is called "favorable" or "biased" selection. Scientific research consistently indicates that Medicare HMOs are the beneficiaries of biased selection.

This research consists of more than a dozen studies done over the last decade. The 1996 report of the Physician Payment Review Commission (an advisory body to Congress) listed twelve such studies. Some of the differences in health status were enormous. The most recent of these studies found that, in the six months prior to signing up with HMOs, spending on those Medicare beneficiaries who signed up with an HMO was only 63 percent of those who chose to enroll in FFS Medicare.

In July 1997, the New England Journal of Medicine published a study comparing hospital utilization rates among HMO and FFS Medicare enrollees in the year before the HMO enrollees left FFS Medicare to join an HMO, and in the three months after some of the HMO enrollees disenrolled and returned to FFS Medicare. The study found that HMO enrollee hospital costs were only 55 percent of the cost of FFS enrollees in the year prior to joining an HMO ($693 versus $1,260 per beneficiary), and that the HMO enrollees who disenrolled and returned to FFS Medicare incurred hospital costs that were double the costs incurred by FFS enrollees ($644 versus $322 per beneficiary) in the first three months after enrollment. The study was entitled, appropriately, "The Medicare-HMO Revolving Door--The Healthy Go In and the Sick Go Out."

These figures suggest that HCFA should be paying HMOs as little as 55 percent of the FFS rate. But HCFA paid 95 percent of the FFS rate between 1985 and 1998, and is currently paying 93.7 percent. Is it any wonder that HMOs can afford to attract healthier enrollees with coverage that is richer than traditional Medicare's?

KIP SULLIVAN is research director for Minnesota COACT (Citizens Organized Acting Together).