Recently, Ezra Klein wrote the following:
Competition hasn’t worked very well in the health-care system. Indeed, Medicare currently includes private options through the Medicare Advantage program. The idea was these private, managed-care alternatives would be cheaper than traditional Medicare. As it turned out, they ended up costing about 20 percent more.
What does it mean when we say that these private, managed-care alternatives wound up costing about 20 percent more?
It is important to understand that the Medicare Advantage program is really weird. Payments to Medicare Advantage plans are based on centrally determined benchmarks. But these benchmarks are thus not a very helpful guide to what might happen under competitive bidding.
Imagine that there is a federal program devoted to providing seniors with cheeseburgers. There is a publicly-run cheeseburger assembly plant that needs $15 to produce a quarter-pound burger with a toasted bun, a sliced tomato, and cheddar cheese. Costs have been rising over the years as the price of the discrete components of this standard cheeseburger have been rising, for a variety of complex, interrelated reasons. In recent years, the federal cheeseburger program has allowed cheeseburger beneficiaries to choose private cheeseburgers at public expense. Various private cheeseburger firms bid for the right to take part in this bonanza of subsidies, and on an enrollment-weighted basis they bid $14 — a bid that reflects what they need to produce that same quarter-pound burger with a toasted bun, a sliced tomato, and cheddar cheese plus enough to turn a profit.
But rather than pay these private cheeseburger firms $14, the amount of the bid, the federal cheeseburger program has devised a complicated benchmark based on what it costs the publicly-run cheeseburger assembly plant to produce said cheeseburger. The end result is that private cheeseburger firms are in many cases paid $16 to take part in the program. This doesn’t mean they pocket an extra $2 in profit, however. These private cheeseburger firms could be required to offer more or higher-quality ingredients — grass-feed beef, romaine lettuce, muenster cheese, fried onions, and so forth. So it is true that these private cheeseburgers cost the system more than the public cheeseburgers. But this reflects the benchmark and, in some cases, the fact that we’re not making an apples-to-apples comparison. And it wouldn’t surprise me if private cheeseburger firms were quite happy with the benchmark system rather than a straight-up competitive bidding system. Why wouldn’t they be?
From the perspective of taxpayers, however, it makes a great deal of sense to use competition to drive down the cost of the standard cheeseburger. The theory of premium support for cheeseburgers is that by having the federal government pay the full cost of the second-cheapest cheeseburger bid, inefficient cheeseburger firms will be forced to lower their cost of production lest they lose all of their customers. The benchmark system lacks this clear market signal, which is one reason it hasn’t worked as well as it should.
So what we really want to know is how much it costs Medicare Advantage plans to provide Part A and Part B coverage to beneficiaries, i.e., the standard cheeseburger. Fortunately, MedPAC offers data on this question. In Chart 9-6 of the June 2012 data book on “Health Care Spending and the Medicare Program,” MedPAC compares Medicare Advantage benchmarks, bids, and and payments relative to the traditional Medicare fee-for-service (FFS) program.
The bids essentially reflects how much the Medicare Advantage plan needs to deliver the service, an amount that covers administrative cost and profit. This creates an opportunity for Medicare FFS — because it isn’t concerned about generating profits, it might have a small but crucial edge.
It turns out, however, that in many counties, private plans bid an amount lower than the amount Medicare FFS needs to offer Part A and Part B coverage. Taken as an enrollment-weighted whole, Medicare Advantage plans bid at 98%, just a shade below Medicare FFS. Private HMOs bid at 95%, which makes for a more substantial savings. Other private alternatives, like private fee-for-service, far poorly relative to Medicare FFS. But of course that makes perfect sense. One can easily imagine, as Austin Frakt has suggested in the past, an equilibrium in which traditional Medicare FFS is the lowest-cost provider in rural counties, in which there is a relatively small number of medical providers with a great deal of leverage. In denser urban markets, with more competition among providers, private HMOs can outcompete traditional Medicare FFS by building more efficient provider networks.