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Managing Medicare's Costs

Fee-for-Service Medicare and surging healthcare costs (1 of 3)

Since Medicare first opened its doors for business in 1965, it has used a fee-for-service approach to health insurance. Original Medicare and Fee-for-Service Medicare are in fact interchangeable terms, with both of them referring to the type of benefit design that has been in place since day one – a design that reimburses providers for each medical service provided.

Medical experts and health policy analysts widely acknowledge that the fee-for-service (FFS) model is broken. For doctors and other providers, the financial incentives of FFS are to increase the number of services, particularly the number of high-cost services. The result is expensive medicine that has poorer health outcomes than would a more reasonably priced system.

Last month the Medicare Payment Advisory Commission (MedPAC) dedicated more than 30 pages of its annual Report to Congress (chapter 3) to the problems associated with the FFS system as well as to possible solutions. The report said that in its current form FFS “encourages growth in the volume and intensity of services and has led to care that is often not coordinated, sometimes inappropriate, and occasionally risky to patients. It has also left beneficiaries with rising Part B premiums and out-of-pocket costs and has left taxpayers with the unsustainable burden of financing the program” (page 65).

Some 75 percent of Medicare’s beneficiaries have fee-for-service coverage. The majority of them also have supplemental plans that cover most or all of the costs that Medicare does not pay, and so they owe little or nothing for most medical services. From their perspective, then, FFS may appear to work fairly well.

But as the MedPAC report says, FFS is expensive. And some of its costs are perhaps hidden from retirees’ view. Part B premiums, for example, have increased at an annual rate of more than 8.7% over the past decade (from $50 a month in 2001 to $115.40 a month this year). These increases have consistently outpaced the rate of healthcare inflation partly because retirees are using more services and getting more treatments, pushing up Part B’s costs.

In her 2007 book Overtreated, Shannon Brownlee described the efforts of Dr. John Wennberg and his colleagues at Dartmouth University who have spent their careers researching regional variations in the use of medical services. Why are there twice as many procedures per capita in some geographic areas? Why do some areas have higher utilization rates for certain procedures decade after decade? And do the cities and counties that receive the most medical care enjoy better health?

The researchers eventually created the Dartmouth Atlas of Healthcare, which uses Medicare data to track the number and cost of medical services provided in each area of the country. They found that Medicare beneficiaries who lived in high-cost regions were in fact less healthy and had slightly higher chances of dying. By one Dartmouth researcher’s estimate, 30,000 people enrolled in Medicare were being killed each year by too many procedures and treatments, each of which comes with a some added risk. Meanwhile people who lived in areas where fewer medical services were used were healthier and had lower healthcare costs.

Is it possible that more medical services are used in certain areas because the residents there are older and sicker? The Dartmouth data indicate that’s not the case, with the variations in the number of services used appearing to be driven more by local medical customs and practices than by health needs. Also, areas with more physicians per capita tend to have higher costs – since there are fewer patients to go around, some doctors may make up the difference by delivering more services per patient.

Harvard surgeon Atul Gawande addressed the question of why some areas have higher costs in a 2009 article in The New Yorker magazine. The article focused on the city of McAllen, Texas, near the Mexican border. In 2006, Medicare spent $15,000 per beneficiary in McAllen, making it the second highest-cost area in the nation after Miami. At the time, the average annual wage in McAllen was $12,000, or $3,000 less than Medicare was spending per beneficiary. Gawande contrasted McAllen’s $15,000 number to the $7,500 that Medicare spent per beneficiary in El Paso, a city with demographics similar to McAllen’s.

Equally important, Medicare data indicated that McAllen was providing healthcare that was inferior to El Paso’s. On average, McAllen’s five largest hospitals performed worse on 23 of the 25 metrics that Medicare uses to gauge hospital quality than was the average El Paso hospital. When Gawande discussed with six McAllen physicians the reasons behind the city’s high healthcare costs, the doctors concluded that the main reason was the overuse of medical services.

So what does this mean, if anything, for retirees seeking to manage their healthcare costs? There’s nothing they can do about Medicare’s national utilization rates or spending trends. Those in Advantage plans already have the lowest-cost options, and there’s little they can do other than monitor their out-of-pocket expenses and manage their prescription drug costs.

People with comprehensive Medigap plans C and F can perhaps switch to Plan M or Plan N and save several hundred dollars a year in premiums with modest increases in cost-sharing. Because they are so comprehensive, Plans C and F are mentioned in the MedPAC report as examples of coverage that allows beneficiaries to use medical services with little or no thought as to their cost.

It’s worth noting that Plans C and F account for almost 60% of the 10 million currently owned Medigap policies. Moreover, they are overpriced relative to their benefits because insurance companies know that retirees who own Plans C and F have no financial incentives to use medical services prudently. Plans M and N, on the other hand, sell at discounts to their actuarial values because insurance companies know that the people who buy these policies are healthy and also will be deterred by the plans’ cost-sharing from using medical services thoughtlessly

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