The Agenda

Guest Post by Bryan Dowd: A Reply to Peter Orszag on Competitive Pricing in Medicare

Editor’s note: Bryan Dowd, a professor in the Division of Health Policy and Management in the School of Public Health at the University of Minnesota, generously agreed to write a reply to Peter Orszag’s most recent column in Bloomberg View on the role of risk adjustment in the Medicare reform debate. Dowd, a co-author of Bring Market Prices to a Medicare, has been working on Medicare reform for decades, and we’ve discussed his work on a number of occasions in this space. 

In a recent editorial, Peter Orszag, former director of President Obama’s Office of Management and Budget, offers a number of objections to premium support. Unfortunately, his objections are characterized by misdiagnosis of the problem, failure to address the most compelling question regarding premium support, and failure to offer a plausible alternative.

Mr. Orszag tells us that “… we must remember that the goal is to reduce total cost.” As Mark Pauly explained twenty-two years ago in an article entitled “Financing Health Care,” reducing cost is no more proper a goal for health care than for personal computers. The problem with health care is not that we spend too much, per se, but that our spending is inefficient. We are not getting a dollar’s worth of benefits from the dollars that we spend. We buy too much health insurance coverage and then waste money on treatments that are overpriced and often medically ineffective.

But suppose for the sake of discussion that Mr. Orszag is correct and total spending is the real problem. If the problem is that we spend too much on health care, our first step should be to end the government subsidies of health insurance and health care services, except for the destitute. That would mean getting rid of the tax deductibility of health insurance premiums and out-of-pocket spending on health care services and vastly reducing the government’s subsidy of Medicare premiums, including the open-ended subsidy of traditional fee-for-service (FFS) Medicare. The good news is that if we pursued the obvious solution to Mr. Orszag’s mischaracterization of the problem, it actually would provide an effective approach to the real problem.

There are two ways to improve efficiency in the market for health insurance and health care services. These approaches are neatly described in two Sounding Board articles in the New England Journal of Medicine on August 1, 2012. The first is a central planning approach described by Ezekiel Emmanuel and a host of co-authors, including Mr. Orszag. The title of the article, “A Systemic Approach to Containing Health Care Spending,” reflects Mr. Orszag’s mischaracterization of the problem. Their proposal admittedly has more market-oriented elements than the 2010 Patient Protection and Affordable Care Act, but their ultimate policy levers are price controls and politically-determined limits on total spending.

The second approach, described by Joseph Antos, Mark Pauly and Gail Wilensky, relies on disaggregated decisions at the individual consumer and provider level accompanied by incentives to encourage efficient consumption.

Since Mr. Emmanuel and Mr. Orszag believe that the real problem is total spending, their proposed solution essentially is a political resolution to spend less, accompanied by a long and detailed list of regulatory recommendations. In contrast, Mr. Antos, et al., apparently would allow consumers to spend as much as they like on health care, but only in the absence of vastly reduced government subsidies and additional incentives to pay attention to cost.

Health plans and health care providers are likely to prefer Mr. Emmanuel’s approach because it is relatively easy for them to control centralized political decisions as opposed to the disaggregated, price-sensitive decisions made by millions of individual consumers. As an example of the former, consider Congressional attempts to rein in Medicare spending on physician services through the Sustainable Growth Rate (SGR) legislation. Under pressure from physicians, Congress repeatedly has ignored its own legislative mandate to cut physician fees over the past decade. The “law of the land” now requires Medicare physician fees to be cut by nearly thirty percent. I will leave it to the reader to decide whether it is more appropriate to apply Mr. Orszag’s “tooth fairy” analogy to the likelihood of that fee cut or the effects that would result from more price-sensitive consumers.

And that brings us to premium support proposals for Medicare. The first noteworthy point about premium support proposals is that they are not new. As described in Competitive Pricing for Medicare (AEI, 1996), a fixed government contribution to Medicare premiums based on health plan bids first was proposed by Ralph Saul of the INA insurance company in Congressional testimony to Congress in 1979. Walt McClure made a similar proposal in 1982, followed by Alain Enthoven’s proposals in 1988 and 1989. With my colleagues at the University of Minnesota, I developed a detailed premium support proposal for the Centers for Medicare and Medicaid Services (CMS), then the Health Care Financing Administration (HCFA) in the late 1980s and later assisted CMS in attempts to demonstrate premium support in four U.S. cities under the Clinton Administration. After Congress mandated those demonstrations, they later were blocked by local court actions and bipartisan members of Congress in whose districts the demonstrations were scheduled to take place. The sordid details can be found in A Tale of Four Cities, published in Health Affairs in 2000.

Nonetheless, there were some interesting results. Despite the fact that the 1990 demonstrations were a weak form of premium support, with competitive bidding only by private plans and not including FFS Medicare, the private plan bids for the entitlement benefit package in Denver were 25 to 38 percent below their government-determined payment rates at that time. If the private plans were placed in direct price competition with FFS Medicare, their bids might have been much lower. Currently, low “bids” by private plans in Medicare – below the “benchmarks” – are taxed by the federal government at 25 percent. Under premium support there would be no such tax.

Mr. Orszag apparently believes that the savings suggested by the Denver bids and the generous additional benefits offered by private plans in high payment areas like Miami, all can be explained by the enrollment of relatively good risks by private health plans. Perhaps he’s right and properly risk adjusted bids from private health plans would be no lower than FFS Medicare’s bid in any market area. My response is, “Let’s find out.” It’s an empirical question that deserves an empirical answer.

Proper risk adjustment of health plan premiums is an important problem, though by no means a new one, and applies to both enrollment and disenrollment processes. Under premium support, the problem with inadequate risk adjustment is not overpayment of private plans, but distorted out-of-pocket premium differentials faced by beneficiaries. If, over time, there was compelling empirical evidence of inadequate risk adjustment, then it would be relatively easy to make direct adjustments to beneficiary out-of-pocket premiums.

Debates over the potential savings from premium support miss the fundamental question that underlies those proposals: “What has traditional FFS Medicare done to deserve an open-ended federal subsidy and protection against full competition with private plans?” We know more about the price and quality of public and private health plans in Medicare than in any other population. Extensive reviews of the literature by Miller and Luft in 1997 and 2002 showed that quality of care is roughly equivalent in FFS Medicare and private plans. FFS Medicare seems to do a little better on chronic care and private plans do a little better on preventive care, including early detection of cancer.

There is a legitimate role for both FFS Medicare and private plans in the Medicare program. The private plans are more administratively nimble. They do not require an Act of Congress to test improvements in financing and delivery of care. However, FFS Medicare is universally available, and obviously would be the low bidder in areas with no private plans. FFS Medicare also has the market power necessary to offset the effect of monopoly pricing power among physicians and hospitals in markets where we have failed to enforce the antitrust laws. It’s a second-best approach to the antitrust problem, but better than nothing.

The recent Congressionally mandated overpayment of private plans in Medicare was extremely ill-advised. What Mr. Emmanuel, Mr. Orszag and their colleagues apparently fail to grasp is that overpayment of FFS Medicare in markets where private plans can provide the entitlement benefit package at a lower premium is equally ill-advised. Waste is waste, regardless of who benefits from it.

Premium support alone cannot save the Medicare program from insolvency, but premium support proposals do not rely on an insolvency argument. Even if the Medicare Trust Funds were in stellar financial shape, wasting taxpayer money on subsidies of inefficient health plans still would be a bad idea.

In addition to premium support, there are proposals to raise the retirement age; increase Part B premiums, coinsurance, and deductibles; end the federal subsidy of Medigap premiums; and improve consumer information on prices and quality. We should do them all, do them now, and do them for everyone – current beneficiaries should not be exempt. We also must bring greater efficiency to FFS Medicare, including bundled payments, value-based payments, and incentives for better coordination of care. The intergenerational transfers required to cover the mass of boomers who are aging into Medicare represents a difficult policy problem, but the answer cannot be to have the entire excess bill borne by our children and grandchildren. Boomers (my generation) must bear a fair share of the “boomer burden.” It is disingenuous for boomers to say, “We paid in as much as we were told to pay in” after spending their pre-Medicare voting years threatening politicians who approached the “third rail” of entitlements by proposing higher payroll and income taxes.

The Medicare program suffers from the same problem as all other entitlement programs. Politicians have a strong incentive to offer taxpayers something for far less than the something actually costs. Governments in many Western developed countries have proven themselves incapable of imposing fiscal discipline on themselves or their citizens, leading to one fiscal crisis after another. Americans long have been known for their pragmatic common sense. It will be a sad legacy for my generation if we run the Medicare program into the ground. When you find yourself in a deep hole of inefficient health care spending, common sense suggests that the first step is to discard the government subsidy shovel.


Antos, Joseph R., Pauly, Mark V., and Gail R. Wilensky. “Bending the Cost Curve through Market-Based Incentives,” New England Journal of Medicine: Sounding Board (August 1, 2012).

Dowd, Bryan E., Feldman, Roger and Jon Christianson. Competitive Pricing for Medicare. American Enterprise Institute Press: Washington, D.C. (1996).

Dowd, Bryan E., Coulam, Robert and Roger Feldman. “A Tale of Four Cities: Medicare Reform and Competitive Pricing,” Health Affairs 19:5 (September/October, 2000) 9-29.

Emmanuel, Ezekiel, et al. “A Systemic Approach to Containing Health Care Spending,” New England Journal of Medicine: Sounding Board (August 1, 2012).

Miller, Robert H. and Harold S. Luft. “HMO Plan Performance update: An Analysis of the Literature, 1997-2001,” Health Affairs 21:4 (July/August 2002) 63-86.

Miller, R.H. and H.S. Luft. “Does Managed Care Lead to Better or Worse Quality of Care,” Health Affairs 16:5 (September/October, 1997) 7-25.

Pauly, Mark. “Financing Health Care,” Quarterly Review of Economics and Business 30:4 (Winter 1990) 63-80.


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