Trade-offs Abound: How To Think About Medicare Reform Options

There are no free lunches when it comes to reducing Medicare spending

We’ve established that federal spending is on an unsustainable path and Medicare cost growth is driving a sizable portion of our long-run problem. How much of a problem? It’s sizable. Medicare is projected to add over $8 trillion to federal debt over the next 10 years. The budget math is clear. Getting the federal budget on a sustainable path isn’t likely to happen without significant Medicare reforms.

What isn’t clear is which Medicare reforms we should pursue to achieve meaningful budget savings. There is no free lunch with the program. Sure, there is waste, fraud, and abuse in the program, but there isn’t that much. Instead, significant reforms will have large political, economic, and health consequences for recipients, providers, and insurers.

Who Should Face the Costs of Medicare Reforms?

Even just wrapping your head around possible Medicare reforms is hard because there are so many players involved and so many parts to Medicare. Contrast that with Social Security, where the options boil down to “Cut benefits, limit eligibility, raise taxes, or some combination.”

Within Medicare, making changes to Part A (hospital coverage) doesn’t necessarily fix structural issues in Part B (doctor’s visits), Part D (prescription drugs), or arrangements within Medicare Advantage (supplemental coverage). Without many opportunities for a free lunch, reducing federal Medicare spending ultimately means shifting costs from the government to someone else. Medicare is complex, but there aren’t that many groups to choose from. The big groups are:

1. Enrollees

2. Providers (e.g., physicians, nurses)

3. Hospitals

4. Insurers

5. Drug companies and device makers

Congress could try to focus reforms on any one of these groups, but that doesn’t mean that group will necessarily bear the burden of the reform. There’s a long history of the government trying to shift costs to one group only to find that the economics meant someone else would be paying for it.

For example, there’s a growing effort to reform Medicare Advantage (MA). MA providers have been accused of “upcoding” patients. They diagnose recipients with more conditions—perhaps even imaginary maladies—to extract bigger payments from Medicare. The Wall Street Journal practically has a regular feature discussing how United Healthcare, Humana, and other MA providers have collected billions in extra payments through these schemes.

Stopping these MA payments schemes would save Medicare billions in dollars. But the billions wouldn’t necessarily come from insurers’ profits. The competitive bidding process in MA means that, over the long-term, insurers must pass on the extra payments to recipients in the form of lower cost-sharing requirements, extra services, or other benefits. In fact, the Wall Street Journal recently noted that efforts to restrain MA spending growth have already led insurers to leave certain markets—leaving Medicare recipients with fewer options.

Similarly, the Inflation Reduction Act (IRA) featured several efforts to reduce Medicare drug spending. This included a $2,000 maximum out-of-pocket cap on prescription drug cost sharing in Medicare Part D. Spending above that limit was to be covered primarily by insurers. Unsurprisingly, insurers didn’t simply eat the cost and pay for it. They raised premiums. Wanting to avoid substantial premium increases in an election year, the Biden Administration ultimately provided insurers an extra $15 per enrollee each month.

The IRA also tried to reduce drug costs by directly negotiating drug prices. The aim was to reduce costs for the government and recipients by paying drug makers less. Danny’s research with John Cogan and Casey Mulligan, however, shows drug makers are likely to try to mitigate the price changes by raising launch prices. More than half of the promised savings from the IRA’s negotiation program could prove illusory as a result.

Now, there are legitimate political reasons why these reforms might still make for good spending reforms. In the case of MA, there would likely be a short-term effect on insurers. And over the long-term, recipients might not realize that the MA reforms limiting upcoding are responsible for less generous MA plans. Letting lawmakers hide behind complicated reforms where the long-term effects aren’t obvious isn’t necessarily a bad thing!

Thinking About Big Picture Changes

Like we said, picturing fixes to Social Security and who prefers them is relatively easy. Democrats propose increases on the tax side (generally for high-income earners) and Republicans favor slowing the growth rate of future benefits. Seniors and the AARP are supportive of any increases to benefits.

But what about Medicare? We’re mostly focused on cost-saving options that either reduce payments to various healthcare providers (like doctors, hospitals, insurers, and drug makers), increase cost-sharing requirements for enrollees, or limiting what services providers and insurers are allowed to offer. The key questions for each reform will depend on the group:

• Enrollees: How will the reform affect their premiums and how much are they going to pay out of pocket?

• Providers and Hospitals: How much will the federal government pay them for each service provided? Who will be allowed to provide care and in what form?

• Insurers: How much will Medicare pay them, what strings will be attached, and how do the government and insurers handle the inherent risks of enrolling particularly costly participants?

• Drug companies and medical device makers: What will they be allowed to charge enrollees, what drugs will be covered, and what role will the federal government play in determining what constitutes a reasonable price?

Some Lunches Could Come with a Free Dessert

There might not be free lunches within Medicare (or even low-hanging fruit), but some reforms might do more than merely shift costs. The best reforms are the ones that improve incentives in the program. If a reform reduces utilization without producing worse outcomes, that’s a clear win (although even then some providers and hospitals might not appreciate it). A few examples:

Shifting costs to recipients through more cost-sharing requirements may create incentives to reduce consumption of low-valued treatments. This isn’t merely hypothetical. Since the RAND Health Experiment in the 1970s, research has consistently shown that when patients face extra cost-sharing requirements they change their health consumption.

Likewise, revising payment methods to providers or hospitals could encourage more efficient care delivery. In the 1983, for example, Medicare replaced its open-ended inpatient reimbursement system with its inpatient prospective payment system (IPPS). Prior to the reform, hospital payments were based on the actual cost incurred, giving hospitals little incentive to contain costs. IPPS replaced the open-ended reimbursement system with fixed payments based on a patient’s diagnosis group. This change gave hospitals less incentive to provide unnecessary services. The results were dramatic. As shown in the figure below, the length of hospitals stays for Medicare recipients fell immediately.

A Framework for Assessing Reforms

With these ideas in mind, in subsequent posts we’ll assess specific Medicare reforms. We’ll ask a few questions for each reform.

• What is the effect on the federal budget?

• Who will ultimately pay for it?

• Does it improve incentives?

• Is it politically possible?

• Is the reform sustainable?

The last one is important. Over the last 40 years, Congress has implemented several cost-saving reforms to federal health spending. Many proved fleeting once the public learned of their consequences. Think the ACA’s Independent Payment Advisory Board (IPAB), the ACA’s “Cadillac tax,” the 1990s-era Sustainable Growth Rate (SGR) “doc fix,” 2015 MACRA physician fee reforms, and the Medicare Catastrophic Coverage Act of 1988.

The budget math doesn’t work if we don’t reduce Medicare spending by trillions in the next decade. Every option is unpopular with powerful interest groups. But that shouldn’t stop us from being prepared when a fiscal crisis inevitably forces the hands of Congress and the president.

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