Magazine | May 2, 2011, Issue

Paul Ryan’s Medicare Fix

How to improve health care and shore up the federal budget with one entitlement reform

Of all the sweeping reforms in Rep. Paul Ryan’s 2012 budget, none is more politically charged than the proposal to transform Medicare from what it is today — an entitlement with no spending bounds — into a “defined contribution” program with a fixed and predictable budget. “Radical.” “Extreme.” “Cruel.” “The end of Medicare as we know it.” The ink wasn’t dry on Ryan’s plan before groups in the Democratic political orbit began launching their rhetorical attacks. And don’t expect the demagoguery to end before November 2012.

Why did Representative Ryan include in his budget plan a controversial entitlement reform, giving Democrats something to exploit for political gain? Certainly Ryan wasn’t unaware of what was coming. He grabbed hold of the third rail of Social Security and Medicare reform more than three years ago, when he proposed his precursor to this year’s Republican budget, “A Roadmap for America’s Future.” Since then, his opponents have thrown everything — and the kitchen sink — at him. So why is he now asking his Republican colleagues to join him on his lonely crusade?

The answer is straightforward: They have no choice. Fixing the federal budget — the raison d’être of the new Republican House — is impossible without slowing the increase in health-care costs. And that can’t be done without a thorough restructuring of Medicare. It’s a daunting challenge, but the reward will be great: a federal budget without crushing tax hikes, and a health-care system that works for patients, not the government.

Even the Obama administration agrees that Medicare is at the heart of the health-care-cost problem. Everything it claims will “bend the cost curve” of health care is a change in how Medicare works and pays for care.

That’s no small concession. For many years, Democrats were in complete denial about Medicare’s cost-raising features. They likened Medicare to a railcar attached to a runaway freight train: The only way to slow down Medicare would be to slow down the whole train — that is, to make health care cheaper for everyone. But now there is widespread recognition on both sides of the aisle that Medicare is the train’s engine (or, at a minimum, the most important engine).

American health care has virtues. We have highly skilled physicians and capital-intensive inpatient institutions, and our system is open to medical innovation in ways that other systems around the world are not.

But there is no denying that health care in the U.S. is highly inefficient. The system is characterized by extreme fragmentation. Physicians, hospitals, clinics, labs, and pharmacies are all autonomous units that are financially independent. They bill separately from each other when they render services to patients. What’s worse, there’s very little coordination of care among them, which leads to a disastrous level of duplicative services, and often to low-quality care. The bureaucracy is maddening, the paperwork is burdensome and excessive, and there is very little regard for the convenience and comfort of patients.

At the heart of all this dysfunction is Medicare — and more precisely, its dominant fee-for-service (FFS) insurance structure.

Medicare’s FFS insurance is the largest and most influential payer in most markets. As the name implies, FFS pays any licensed health-care provider when a Medicare patient uses services — no questions asked. More than 75 percent of Medicare enrollees — some 35 million people — are in the FFS program. Physicians, hospitals, clinics, and other care organizations most often set up their operations to maximize the revenue they can earn from FFS payments.

#page#In June 2009, Atul Gawande wrote an influential article for The New Yorker in which he contrasted the high-use, high-cost care provided in McAllen, Texas, with the less costly and higher-quality care provided at institutions such the Mayo Clinic. But what Gawande did not explore is what allowed a delivery structure such as McAllen’s to develop in the first place. The answer is Medicare. Without Medicare payments for every physician-prescribed diagnostic test and surgical procedure, the expensive infrastructure that was built in McAllen would never have been viable.

For FFS insurance to make any economic sense at all, the patients must pay some of the cost when they receive health care. Otherwise, there is no financial check against the understandable inclination to agree to all of the tests, consultations, and procedures that a doctor offers to perform, no matter how small the expected benefit.

But Medicare’s FFS system does not have effective cost-sharing at the point of service. Yes, the program requires cost-sharing, including 20 percent co-insurance to see a physician. But the vast majority of FFS beneficiaries — nearly 90 percent, according to the Medicare Payment Advisory Commission — have additional insurance in the form of Medigap coverage, retiree wrap-around plans, or Medicaid, and it covers virtually all costs not covered by FFS. Further, Medicare’s rules require providers to accept the Medicare reimbursement rates as payment in full, effectively precluding any additional billing to the patient.

In the vast majority of cases, then, FFS enrollees face no additional cost when they use additional services, and the only way for health-care providers to earn more is to provide more. So it is not at all surprising that Medicare has suffered for years from an explosion in the volume of services used by FFS participants. The Congressional Budget Office reports that the average beneficiary used 40 percent more physician services in 2005 than the average beneficiary did eight years earlier, and spending for physician-administered imaging and other tests was up approximately 40 percent in 2007 compared with 2002.

FFS also stifles much-needed service-delivery innovation. The payment rules, established in regulation, reward higher use of last year’s services, offered by last year’s list of qualified providers. New service-delivery organizations, pricing approaches, and ways of taking care of a patient (such as over the Internet and phone) are simply not accommodated by the payment rules, which in some cases were written two decades ago. Even small changes can take years to implement; often, a multi-year test is required. Providers are thus reluctant to invest in new approaches, no matter how promising, that will pay off only if Medicare accommodates the change. The result is that today’s fragmented, dysfunctional, and costly system is virtually frozen in place — for all users of U.S. health care, not just Medicare patients.

Ever since House Republicans introduced their 2012 budget plan, liberals have been howling about the supposed cuts in health care for seniors that would happen under the Ryan Medicare reform. But what they never mention is that Obamacare capped overall Medicare spending.

That’s right. Obamacare imposes an upper limit on Medicare spending growth every year, beginning in 2015. This is not yet widely understood among voters, probably because the Obama administration doesn’t want it to be. And, for some Americans (and reporters), maybe it is just too hard to believe that the most liberal Congress in a generation placed a spending cap on one of the Left’s iconic entitlement programs.

#page#But make no mistake: That’s exactly what it did. Beginning in 2015, growth in per capita Medicare spending will be limited to a fixed rate, initially set at the midpoint between general inflation in the economy and inflation in the health sector. Starting in 2018, it will be set permanently at per capita–GDP growth plus one percentage point.

To enforce the cap, Obamacare’s authors resorted to a favorite liberal solution: a board of technocrats. The 15-member Independent Payment Advisory Board, or IPAB, is charged with coming up with ways to hold Medicare spending below the annual caps.

To hit its budgetary targets, IPAB is strictly limited in what it can recommend and implement. It can’t change cost-sharing for covered Medicare services. Indeed, it can’t change the nature of the Medicare entitlement at all, or any aspect of the beneficiary’s relationship to the program. The only thing it can do is cut Medicare payment rates for those providing services to the beneficiaries.

Obamacare’s apologists argue that this cap will spur innovative “delivery system” reforms that will cut costs with no pain to the program’s participants by steering patients to higher-quality, lower-cost providers of care. But this is wishful thinking in the extreme. The federal government has never shown any capacity to build and maintain what might be called a high-quality delivery system in Medicare. Indeed, the whole point of the Medicare FFS model is that beneficiaries get to see any licensed provider they choose, to whom Medicare pays a fixed reimbursement rate. When attempts have been made to steer patients toward preferred physicians or hospitals, they have failed miserably. Politicians and regulators have found it impossible to choose among hospitals and physician groups, because the available quality measures are disputed.

Instead, Congress and Medicare’s regulators have cut costs the old-fashioned way: with across-the-board payment-rate reductions that apply to every licensed provider, without regard to any measures of quality or efficiency. Tellingly, that’s exactly how Obamacare cuts Medicare spending, by nearly $500 billion, over the coming decade, and that’s exactly how IPAB will meet the new Medicare cap under the law in the future.

The risks to Medicare’s participants from this approach to cost-cutting are very real. The chief actuary for the Medicare program has warned repeatedly over the past year that Obamacare’s cuts will drive scores of providers from the program because payments will be too low to cover their costs. He expects 15 percent of the nation’s hospitals to drop out of the program by the end of the decade. At that point, Obamacare’s cuts would have driven average Medicare payments below those paid by Medicaid, which are notoriously low.

The Obamacare “solution” for Medicare is nothing of the sort, and nothing new at all. It’s an approach that has never worked to control costs in the past, and it won’t work this time. All price controls ever do is drive out willing suppliers, after which the only way to balance supply and demand is with waiting lists.

The Ryan alternative starts from an entirely different premise. Its solution is not top-down cost-cutting but a more productive and efficient health sector. The only way to slow the rise in costs without compromising the quality of American health care is by getting more bang for the buck: making the provision of services to patients more efficient each year.

That can be achieved in health care the same way it has been achieved in other major sectors of the American economy: with a robust, well-functioning marketplace, filled with cost-conscious consumers. That’s the centerpiece of the Ryan Medicare reform.

#page#Beginning in 2022, new Medicare enrollees would get their entitlement in the form of a “defined contribution” or “premium support” payment from the government (those who turn 65 before 2022 would be exempted from the switch). Initially, the entitlement would be set at roughly the average cost of Medicare coverage. In future years, its value would grow at the rate of general inflation. Beneficiaries would be given a menu of insurance options on which they could spend their entitlement. Importantly, the value of the entitlement would be set independently of whatever insurance plan they selected. If beneficiaries selected plans with higher-than-normal premiums, they would pay the extra cost themselves. If they selected less expensive options, their out-of-pocket expenses would reflect the lower price of coverage.

Critics argue that this change would do nothing to control health-care costs, but would shift the risk of rising costs onto individuals because the government’s support would no longer keep pace with premium growth.

However, the goal is not to shift rising premium costs onto beneficiaries, but rather to set in motion an entirely different market dynamic that will achieve greater efficiency. With cost-conscious consumers looking for the best value for their money, cost-cutting innovation would be rewarded, not punished as it is today. Physicians and hospitals would have strong financial incentives to reorganize themselves to become more productive and efficient and thus capable of capturing a larger share of what would become a highly competitive marketplace. That’s the only way to slow the growth of health-care costs without harming the quality of care.

The government plays an important oversight role in Ryan’s Medicare-reform plan, as it should. Participating insurance companies must offer transparent pricing and meet minimum-benefit and -quality standards. But decisions about where to put limited resources should be made by individual consumers, not the federal government.

The Obama administration would like to see high-quality, low-cost networks form in every region of the country. That’s a worthy goal. But the federal government has no capacity to make that happen. Those networks will form only when it is attractive and profitable for them to do so, on their own, organically and in the communities in which they operate. And that means unleashing the power of competition to reward innovators and entrepreneurs.

Medicare’s prescription-drug benefit became the first truly competitive market in the program when it was enacted in 2003. Beneficiaries get a fixed-dollar entitlement that they can use to buy coverage from a number of different competing plans. The insurers understand that they have to keep costs down to attract price-sensitive enrollees. And the government has no role in setting premiums or drug prices. And how is it working? Costs are now expected to come in 47 percent below original expectations over the first decade.

The federal government’s health-care administrators have been trying to micromanage Medicare to control costs for four decades now. They haven’t succeeded, yet Obamacare doubles down on their failed model, this time with an arbitrary cap on spending that poses great risk for beneficiaries.

Paul Ryan has a different vision and solution, grounded in the American experience. He understands that the best way to help the program’s future enrollees is to give them more control. When the beneficiaries, not the government, direct the entitlement, the entire health-care system will reorient itself to deliver what they want and need at an affordable price. That’s the way to patient-centered care. That’s the way to rewarding productivity and efficiency in the health sector, and making health care more affordable for everyone, including the uninsured. It’s the most important step toward fiscal sanity, too.

– Mr. Capretta is a fellow at the Ethics and Public Policy Center. He was an associate director at the Office of Management and Budget from 2001 to 2004.

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