Pay or pay: managed care will not save Medicare, but a dose of reality might.

Mr. Merline is Washington correspondent for Investor's Business Daily.

HOUSE Speaker Newt Gingrich confused a lot of people with his recent talk about separating Medicare reform from the budget process. After all, any credible balanced-budget plan will have to deal with the $170-billion Medicare program. Yet Gingrich is right about one thing: Medicare's looming fiscal crisis would have to be addressed even if the Republicans hadn't promised to balance the budget. The problem is that the idea they have seized upon to "transform" Medicare probably won't work.

Medicare's latest annual report paints a grim picture. Despite more than a decade of cost-control efforts, Medicare costs are expected to grow by more than 10 per cent annually during the next five years. Under current rules Medicare's Hospital Insurance program (Part A) will face a shortfall of $47 billion by 2002. When the baby-boomers start retiring, the deficit will top $100 billion; it will explode to $1.4 trillion by 2035. Part B, which covers physician services, is in even worse shape. Funded largely through the Treasury, with a small portion paid by the elderly in monthly premiums, Part B is expected to triple in cost over the next ten years.

Despite this explosive growth, Medicare continues to leave the elderly exposed to catastrophic medical expenses, and it has failed to control routine health costs for the elderly, who pay 50 per cent more for health care today as a share of income than they did before Medicare started. If history is any guide, cost control will prove very difficult. Since the early 1980s, Medicare has clamped down on fees paid to hospitals and doctors, stepped up efforts to control fraud, and increasingly meddled in doctors' practices, but to little avail.

The package of Medicare reforms that the Republicans are pushing may not do much better. The centerpiece of most GOP reform proposals offered to date is gradually replacing Medicare's antiquated fee-for-service payment system by encouraging the elderly to enroll in managed-care plans. The thinking is that managed care has worked wonders in the private sector, and that it could do the same for Medicare. Republicans assume that moving more of the elderly into managed care would cut costs without cutting benefits. Bill Thomas (R., Calif.), chairman of the House Ways and Means Health Subcommittee, recently lined up witnesses who advocated this approach.

Medicare is already headed in the direction of managed care, with some 2 million elderly in 26 states enrolled in health-maintenance organizations that have contracts with Medicare. But the results are not encouraging. For each Medicare patient it enrolls, an HMO gets a flat fee equal to 95 per cent of the average Medicare fee-for-service costs in the area. "By definition, every citizen who decides to take a Medicare HMO in that state is saving the taxpayer 5 per cent of the average cost of Medicare," Gingrich said in testimony before the Ways and Means Committee. While the logic seems sound, a recent General Accounting Office study concluded that the HMOs actually end up costing the program more money. The GAO found the HMOs have, by design or accident, enrolled mostly the healthy elderly, whose health-care costs are less than 95 per cent of their states' average, with the HMOs pocketing the difference. As a result, the patients enrolled in Medicare HMOs cost taxpayers 6 to 28 per cent more than if they had stayed in the regular fee-for-service plan.

"Because [the HMO] payment is made per person, and not per service, HMOs have an incentive to . . . enroll only those patients who are expected to have relatively low health-care costs," the GAO report says. Anecdotal evidence suggests that HMOs have discouraged sicker patients from signing up or sticking with the plan. "Once patients become very ill, some HMOs encourage them to disenroll," says Marilyn Moon, a senior fellow at the Urban Institute.

And, the GAO says, since the HMOs have succeeded in skimming the best risks, the remaining fee-for-service pool is sicker. As a result, the average fee-for-service cost climbs -- and, given the way the deal is structured, so does the 95 per cent fixed payment to the HMOs. "You can't just move people into managed care in a voluntary way and save money," says Miss Moon. "And I'm not sure we're prepared to push everybody into managed care."

Managed-care supporters say the problem is one of design. Set the payment rates properly, they say, and you start reaping big savings. But it is hard to see how HMOs could squeeze more savings out of the provision of care to the elderly than Medicare already has. University of Southern California economist and physician Dr. William Schwartz finds that cutting out wasteful or inefficient health-care spending can do little to reduce overall health costs. Various studies show that HMOs get most of their savings from negotiated discounts with providers, not from greater efficiency. But Medicare already pays providers below market rates, with payments to physicians currently set at only 68 per cent of average private-sector fees. As Bruce Vladeck, head of the Health Care Financing Administration (HCFA), puts it, Medicare "takes its discounts up front" by setting provider rates for doctors and hospitals. Beating Medicare on this score would severely hurt doctors' livelihoods and hospitals' bottom lines. Already, low reimbursement rates have led to complaints about rationing in the Medicare system. Hospitals, according to several studies, are releasing some Medicare patients earlier and in less stable condition than they formerly would. And elderly patients increasingly complain about having difficulty finding doctors willing to treat them.

PR or Results?

THE enthusiasm for the cost-cutting potential of managed care, critics charge, reflects aggressive industry PR more than market results. "The most advanced studies show that despite some employers' tendency to resort to HMOs to save money, managed care is not a panacea," says Greg Scandlen, executive director of the Council for Affordable Health Insurance, which represents small and medium-sized insurers.

A 1993 GAO report found that "little empirical evidence exists on the cost savings of managed care" for employers. Most studies showing a significant managed-care cost advantage fail to account adequately for key factors affecting health-insurance costs, such as the age and health status of enrollees. Because managed-care plans tend to attract younger, healthier workers, their cost savings may be exaggerated.

Whatever savings are available from managed care, they may be one-time events. A Congressional Budget Office study found that "the limited available evidence suggests that managed care does not affect the underlying rate of growth in costs." An employer survey by Foster Higgins appears to confirm this. It found overall premiums dropped by more than 1 per cent between 1993 and 1994, as many businesses shifted workers into managed-care plans. These plans have, on average, lower premiums than fee-for-service policies. But managed-care plan premiums continue to increase at rates comparable to those of fee-for-service premiums. HMO premiums increased 13 per cent between 1992 and 1994, with indemnity premiums climbing 18 per cent. Premiums for so-called point-of-service managed-care plans grew 20 per cent over those years. A survey by Hay/Huggins, a Philadelphia consulting firm, showed that average premiums for family coverage increased faster between 1992 and 1994 in HMOs than in traditional indemnity plans. Over all, according to a study in Health Affairs, real health-care prices climbed 4.3 per cent annually in the first three years of this decade, compared with 0.7 per cent in the 1970s, despite the steady growth in managed-care enrollment during that time. The study also found that the slowdown in spending in recent years has been "modest at best."

Managed care replicates in a private setting the basic economic flaw of Medicare (and the health-care industry in general): an overreliance on third-party payments. Medicare shields patients from most of the direct costs of their own health-care decisions by cutting deductibles and co-payments to the vanishing point. Managed care's selling point to the elderly is that they will face even fewer out-of-pocket costs. As a result, patients have a strong incentive to overconsume. To prevent this, health-care services must be "managed" from the top down, with thousands of administrators enforcing layers upon layers of rules and regu- lations on patients and providers. "Managed-care organizations currently perform regulatory functions that governments do elsewhere and that Medicare does here," writes Dr. Robert Berenson in Health Affairs.

As with Medicare, aggressive cost-control efforts by managed-care companies have led to growing complaints of rationing. Over the last ten years, for example, the HCFA (a U.S. Government agency) has repeatedly found Florida HMOs violating Medicare quality guidelines by delaying or withholding treatment, failing to act on test results, and so on. A study of California HMOs by the Medicare Advocacy Project turned up similar complaints. In one case, a California HMO failed to schedule an eye operation for two years, by which time the elderly patient could no longer drive or read.

Patients with medical problems requiring specialized or costly treatment are increasingly concerned about private-sector cost-control efforts. "Rationing is quickly becoming a fact of life," warns the National Kidney Cancer Foundation. Replacing ham-fisted government rationing with more efficient private-sector rationing will prove cold comfort to the elderly.

Some Republican reformers argue that this problem can be addressed by giving vouchers to the elderly and letting them choose from a range of approved health plans. Competition among plans would ensure both low cost and high quality. The program, advocates say, would resemble the Federal Employee Health Benefits Plan. The Heritage Foundation's Robert Moffit calls the FEHBP "an excellent showcase" for reform.

Not everyone is convinced. "Almost anyone familiar with the health-benefits program for federal employees knows that it is in desperate need of reform," writes John Goodman, president of the National Center for Policy Analysis (NCPA). Measured on a per-enrollee basis, he says, the FEHBP's costs rose 25 per cent faster than premiums in the private sector during the 1980s. Even supporters admit that the FEHBP has barely outperformed Medicare on costs, with average annual increases coming in only 1 percentage point lower between 1976 and 1992. Between 1985 and 1992, the FEHBP's per-capita costs rose nearly twice as fast as Medicare's. The problem, Moffit says, is that FEHBP administrators have a "mindless opposition to high-deductible plans." Let high-deductible plans in and overall costs would drop, he says.

Hence, the NCPA's proposal to allow the elderly to take their share of Medicare funds and use them to buy a high-deductible plan that covers catastrophic expenses, putting the remaining money in a Medical Savings Account. This would expose the elderly more directly to the cost of their care while at the same time protecting them from financial ruin in the case of an emergency. Any money not spent on health care could be saved in the MSA, giving the elderly a powerful incentive to manage their own care. Supporters of MSAs note that companies experimenting with them have been successful at cutting costs.

"The cost-control incentives of MSAs would substantially reduce Medicare expenses over time," the NCPA's Peter Ferrara testified recently. "Over time, Medicare would be reformed into a more rational program protecting the elderly against high medical expenses, but not attempting to pay for all routine expenses. Moreover, through this option, the elderly could escape the rationing and reduced quality of care that is increasingly being imposed on them under Medicare." The important and difficult task is to convince the elderly that there's no such thing as free health care.