What Really Ails Medicare

By Jonathan Cohn, The American Prospect. Posted May 29, 2008.

When Lyndon Johnson signed the law creating Medicare in 1965, he promised that it would transform the lives of America's senior citizens. "No longer will older Americans be denied the healing miracle of modern medicine," Johnson proclaimed. "No longer will illness crush and destroy the savings that they have so carefully put away over a lifetime so that they might enjoy dignity in their later years." As ambitious as those goals were, some of Medicare's architects had even loftier hopes. Many were veterans of Harry Truman's crusade to provide insurance to every single American; it was only after that effort failed that they decided to concentrate on covering the elderly, whom they knew to be a politically sympathetic group. But in focusing on senior citizens, they didn't give up on bringing insurance to the rest of the country. Medicare, they fervently hoped, would be a stepping stone to universal coverage -- and perhaps a model for how to achieve it.

More than 40 years later, universal health care is back on the political agenda. But hardly anyone with actual political power is talking about quickly achieving universal coverage with a Medicare-like program to cover everybody. And while some progressives hope to establish a new public program that could eventually cover everybody -- an idea endorsed by all the leading Democratic candidates for president -- they haven't made this element a prime selling point. Instead, Medicare is just as likely to be invoked by the opponents of universal coverage. As far as they are concerned, Medicare is proof that universal coverage can't work.

Medicare, according to this line of thinking, is a bloated, inefficient program -- one destined to bankrupt the country within a few decades. And it's true: The program's financial situation really does appear dire. According to the most recent official projections, in 2011 the trust fund that pays for hospital benefits will spend more money than it takes in; eight years later, it will run out of money altogether. In the meantime, the Congressional Budget Office predicts, Medicare as a whole will gobble up an ever-increasing share of both the federal budget and our national wealth -- until, by 2080, it's taking up more than 15 percent of gross domestic product. As a stopgap, Congress has tried various Medicare cuts. But those cuts frequently translate into reduced payments to doctors, hospitals, and medical schools, and trickle down to individual beneficiaries in the form of higher premiums for physician services and cost-sharing. That means seniors who use the most medical services -- those who need the most help -- keep spending a larger share of their incomes on medical care. Medicare's financing crisis is real enough. But it does not logically follow that universal health insurance should wait. On the contrary, Medicare costs a lot because medical care in this country costs a lot. The program is trapped in a deeply dysfunctional system -- one in which too much money goes to the wrong uses and not enough goes to the right ones. Unless we want to simply hack away at the program's benefits -- in effect, undoing one of the greatest social-policy advances in American history -- the best way to stabilize Medicare is to think even bigger and fix the rest of the health-care system. The founders had it right: Medicare should be the foundation for reform, not an impediment to it.

Notwithstanding the fiscal projections that make the evening newscasts, Medicare has been wildly successful. It delivered on LBJ's promise to bring the elderly into the mainstream of American medicine, virtually eliminating severe economic hardship as a consequence of the costs of illness among elderly. The program is also hugely popular with the people who use it. Polls have shown that, relative to working families with private insurance, the elderly on Medicare are more satisfied with their coverage. And why wouldn't they be? The program covers virtually any service they might need. It's available to everybody 65 years or older, regardless of pre-existing conditions. And nobody can take the coverage away. This universality also explains the program's efficiency -- no money wasted on marketing or on middlemen profits.

Still, Medicare was a product of political compromises, some of which raised costs. In order to blunt opposition from organized medicine, health-care reform's most traditional foe, Medicare's promoters promised doctors that they could continue to charge their "usual and customary" fees. To win support from hospitals, which were struggling to cope with impoverished elderly patients but remained wary of too much government interference, Medicare promoters allowed Blue Cross to administer the actual payments, further inflating costs. (Nobody expected Blue Cross to scrutinize hospital billing too heavily.) All too predictably, Medicare's expenses skyrocketed. Eventually, the government increased the program's bargaining leverage with doctors and hospitals. In 1983, Congress changed the way Medicare paid hospitals, providing reimbursements based on diagnoses, in the hope that hospitals would be rewarded for providing the most cost-effective treatments. In 1989, the system implemented an explicit fee schedule that effectively set the prices doctors could charge their Medicare patients.

Thanks to the cost-containment efforts, Medicare has actually managed to hold down its costs as well as, if not slightly better than, private insurance. But the program's victory over skyrocketing costs was far from complete. When Medicare reduced its payments to the providers of medical services, the providers turned around and charged more to other payers of premiums, whether insurance companies, employers, or individuals. This is known as "cost shifting." The net shift is impossible to know, because doctors and hospitals try to shift some costs back onto Medicare as other sources of revenue diminish.

As a long-term strategy, however, simply cutting fees across the board tends to have diminishing returns. Service for service, procedure for procedure, Medicare already pays less than most private insurers. Every time a new cut looms, many doctors threaten to stop seeing some or all Medicare patients. That hasn't actually happened yet, according to the Center for Studying Health System Change, perhaps because few doctors can afford to shun such a large group of paying patients. Another reason could be that Medicare, although not the most generous financier of medical care, is one of the quickest. But at some point, cutting fees must restrict access. The proof can be found in Medicare's impoverished sister, Medicaid, which was created by the same 1965 law establishing Medicare. Because Medicaid pays so little -- less even than Medicare -- Medicaid patients frequently have trouble finding doctors who will see them, at least on a timely basis.

So Medicare has now reached the limits of cutting payments as a cost-containment strategy, unless Congress is willing to gut the program. Something that goes beyond past payment reforms is required to avoid the fiscal disaster that the Congressional Budget Office, the Medicare Trustees, and a chorus of fiscal critics project in the near future. But what kind of changes would that entail? That's where the great ideological divide opens up.

For decades, conservatives have been saying that the solution to Medicare's problems lies in making Medicare operate more like the commercial health-insurance market: Have more seniors get their insurance from private carriers rather than from the government and, no less important, encourage them to choose plans with less generous benefits. These steps, they promise, will help control the growth of Medicare spending.

At a time when the public's faith in government is less than what it was when Medicare first came into existence, this sort of thinking has political appeal. But recent history offers a real-life test of this proposition -- and it turns out to be pretty shaky.

In the 1990s, prodded by the insurance industry, Medicare introduced more private insurance options through an initiative called "Medicare plus choice." By that point, private managed care plans had shown themselves capable of holding down medical costs for the working-age population by bargaining harder on prices, limiting payments to physicians, scrutinizing medical treatments, and shifting some out-of-pocket costs to consumers. Medicare-plus-choice sought to make the same sorts of managed care plans available to seniors, as an alternative to the traditional government program, in the hopes it would have a similarly salutary effect.

For a little while, the experiment seemed to work. The plans, some of which offered hard-to-get prescription drug benefits, proved affordable and popular. But soon it turned out the plans were offering more benefits largely because the government was paying them too much money. And their key to profitability was skimming off relatively healthy seniors with selective marketing. When the government cut back on the unnecessary subsidies, plans started dropping out -- creating chaos and leaving recipients scrambling for replacement coverage. It turned out that, given a population of beneficiaries overwhelmingly likely to get sick, private carriers couldn't perform as well as they could with the relatively healthier working-age population.

It was a sobering lesson, but one that President Bush and the Republican Congress chose to ignore a few years later. Under intense political pressure to create that much-needed prescription-drug benefit, Bush and his allies (including some Democrats) complied -- but the twist was that the coverage would come only through private plans, which the government would be subsidizing. The result? Even more overpayments, making the program far more costly than the obvious alternative -- the addition of a drug benefit to conventional, public Medicare. For example, every time a senior citizen opts out of traditional Medicare and enrolls in one of the new "Medicare Advantage" plans (which offer not just drug coverage but a full-blown private alternative to regular Medicare), the federal government has to spend 12 percent more than it would have if the patient had stayed on Medicare.

Although the idea that private insurance might actually cost more than public insurance confounds conservative wisdom, this reality is hardly surprising, given the economics of heath insurance. Government statistics show that around 98 percent of the money flowing into the traditional Medicare program goes back out as payment for medical services and goods. The comparable figure for private insurance companies -- a figure the companies call the "medical-loss ratio," since they consider money spent on patients a "loss" -- rarely goes above 90 percent and, for the bigger commercial carriers, frequently dips down into the 70 percent range and even the high 60 percent range. It's not hard to see why this would be. Commercial carriers answer to Wall Street, which demands profits. As such, they spend lavish sums on marketing -- and figuring out new ways to target the healthiest (i.e., the cheapest to insure) beneficiaries. Medicare does none of these things.

Forcing seniors to bear more costs directly -- the other idea conservatives love to talk up -- might seem like a more promising strategy for containing Medicare spending. Studies have repeatedly shown that people consume fewer medical services when they have to pay more for them. And that's why any sensible insurance program, private or public, asks its beneficiaries to pay for at least some portion of their medical bills out of pocket.

But the higher that cost-sharing goes, the more perilous it becomes. Even putting aside the moral issue -- shouldn't an insurance system protect sicker people? -- it's not clear that hiking out-of-pocket spending actually saves money in the long run, since even relatively intelligent and informed people have a hard time figuring out how to buy medical care wisely. Several recent studies, including one published in The New England Journal of Medicine, looked specifically at the impact of raising drug co-payments for seniors taking medication for chronic conditions. The short-term effect was that seniors spent less money on drugs (good). The long-term effect was that seniors got a lot sicker, requiring more hospitalizations -- which quite possibly cost even more money than the foregone drugs would have (not good).

But if privatizing and pruning Medicare won't save the program from financial turmoil, what will? The answer lies in understanding the real reason why Medicare costs keep going up. Surprisingly, the prime cause is not the aging of the population. If aging were the only factor driving up Medicare costs, the Congressional Budget Office predicts that the program would grow from a little less than 3 percent of gross domestic product today to a little less than 5 percent in 2080. That's serious money but a relatively small portion of the projected overall cost increase.

The real reason Medicare is expected to grow so fast is that all medical spending, for both the elderly and non-elderly, is going up. The reason for that is a combination of newly available technology and an unchecked demand to use it. And this is where Medicare's real problem -- and that of the whole system -- comes into view.

Historically, Medicare, like private insurers, has rewarded doctors and hospitals for performing more procedures. (While the payment reforms of the 1980s, so called "diagnosis related groups," helped mitigate that problem, they didn't eliminate it.) But patients don't actually seem to be better off for the extra attention. The proof of this lies in the now-famous work of John Wenn-berg and his colleagues at Dartmouth Medical School. As they and their disciples have repeatedly demonstrated, Medicare currently underwrites vastly different levels of care in different parts of the country. Seniors in South Florida, for example, get a lot more medical care than seniors in Minneapolis -- apparently because South Florida has a great many more doctors (who often overtreat their patients). But statistically, South Florida seniors don't seem better off for the extra care. That means Medicare must be paying for a lot of unnecessary or counterproductive treatments.

That's why reducing unnecessary care (as opposed to simply reducing care, which is what crude increases in cost-sharing would do) is the first key to Medicare's financial survival -- and the efficiency of the health system generally. Medicare could, for example, offer financial incentives to providers that follow established best practices. Medicare could also reward those that make information about its practices and outcomes publicly available. The incentives to do this can be positive, in the form of bonuses, or negative, in the form of penalties. Medicare might also encourage seniors to enroll in integrated practice settings, like the highly regarded Group Health of Puget Sound, which have been shown time and again to offer some of the most cost-effective -- and, by most measures, the best -- medical care available. This is not the same as simply herding seniors into loosely organized managed care systems, only some of which actually integrate care and emphasize prevention the way places like Group Health do.

Although these sorts of initiatives worry some doctors and hospital lobbyists, who fear the government will get too involved in micromanaging care, the idea actually enjoys bipartisan support in Washington. For all of the damage the Bush administration has done to Medicare through the design of its prescription-drug benefit, it has made steady progress toward introducing payment reforms, which many experts call "pay for performance." (Mark McLellan, former secretary of health and human services, deserves much of the credit.) Presumptive Republican presidential nominee John McCain, although an opponent of universal health insurance, has nevertheless included similar reform proposals in his campaign platform, as have both Hillary Clinton and Barack Obama. Yet because of the overall system's fragmentation, its commercialization, and perverse incentives to spend money in the wrong places, these reforms would be far more potent in the context of a truly universal system.

Another key payment reform is far more controversial: changing the way Medicare buys prescription drugs. One reason Bush and his supporters were so determined to channel the new drug benefit through private insurers was that they didn't want to give government the kind of pricing leverage over the pharmaceutical industry that it already has over doctors and hospitals. And while the opposition to government drug purchasing has more than a little to do with the drug industry's history of campaign contributions to Republicans, it also reflects a philosophical conviction that government pricing would deter innovation.

It's a respectable argument but, again, not one supported by much evidence, because the current system isn't particularly well suited to fostering innovation in the first place. The driving force behind developing new drugs isn't a push for the best new treatments science can concoct. It's a push for the best new products that the pharmaceutical industry can market to gullible consumers and compliant doctors, often trivial variations on existing drugs about to go off-patent. It's undoubtedly true that too much government pressure on drug prices, particularly if applied arbitrarily, could deter useful innovations. But most sensible reformers don't advocate that. Rather, they call for linking drug purchasing to more aggressive judgments on which drugs work -- and which drugs are most cost-effective.

But here again, there are limits to what any Medicare reform can accomplish, if limited to Medicare's part of the system. Medicare is already the largest purchaser of medical services in the United States. But the fragmentation of the system greatly diminishes Medicare's ability to change the way medicine is practiced -- and, in so doing, blunts its ability to control costs. Fragmentation also leads to the cost-shifting problem. When Medicare squeezes -- whether intelligently or crudely -- the providers of medical care react by increasing charges to their other customers, like working-age people covered by private insurers. And what happens when doctors and hospitals can't simply charge more to make up for declining Medicare payments? If they don't simply decide to see fewer Medicare patients, they might decide instead to provide less discounted and free care to the uninsured. That's a form of cost-shifting, too, only the "cost" comes in the form of higher medical debt -- or unmet medical needs -- for people who find themselves without adequate insurance.

All of this suggests why true Medicare reform would go far beyond Medicare. It would fix the whole health-care system by creating incentives for all providers of medical care to observe cost-effective medical practices. It would create new scientific institutions (or redirect existing ones) to establish what those best practices are. It would create some sort of electronic medical record system, to cut down on errors and improve coordination of care -- both of which ought to help reduce costs (not to mention make people healthier). Above all, it would also make sure all patients had a way to pay their bills, so that doctors and hospitals now performing charity care won't have to steal from other funding sources to do it.

In other words, the best way to keep Medicare affordable would be to create a well-functioning universal system. The idea of fixing a program by creating another, even larger one might sound paradoxical. But that's only a function of today's political sensibilities. The argument would make perfect sense to many of Medicare's founders; indeed, it would be true to their original hope that Medicare would open the door to covering everybody. Sometimes, the first impulse is the right one.

Reprinted with permission from Jonathan Cohn, "What Really Ails Medicare," The American Prospect, Volume 19, Number 5: May 12, 2008. The American Prospect, 2000 L Street, Suite 717, Washington, DC 20036. All Rights Reserved.

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Jonathan Cohn is a senior editor at The New Republic, where he has written about national politics and its influence on American communities for the past decade. He is also a senior fellow at the think-tank Demos and a contributing editor at The American Prospect, where he served previously as the executive editor. Cohn, who has been a media fellow with the Kaiser Family Foundation, has written for the New York Times, Washington Post, Newsweek, Mother Jones, Rolling Stone, and Slate. A graduate of Harvard University, he now lives in Ann Arbor, Michigan, with his wife and two children.

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