Government Provision of Health Insurance

1. 12 Government Provision of Health Insurance

2. Learning Goals • Learn the basic features of federal insurance programs (Medicare, Medicaid, and SCHIP) and how, when, and why they emerged in their particular forms. • Understand the economic implications of these program design features in terms of demand, risk management for individuals, and cost. • Follow modifications to Medicare payment mechanisms to hospitals (DRG [diagnosis-related group] or program) and physicians (RBRVS program) and understand the economic and health impacts of these programs. • Learn how capitation programs (HMO, PPO, etc.) work in Medicare and Medicaid, and understand how risk-adjustment mechanisms can affect the viability and value of such programs.

3. In 1965, the U.S. Congress passed and President Lyndon Johnson signed a law adding Titles XVIII and XIX to the Social Security Act. • Title XVIII created a universal and mandatory health insurance program for the elderly called Medicare, subsequently expanded to include persons permanently disabled for at least two years and persons with otherwise fatal kidney disease (so-called end-stage renal disease, or ESRD) who need kidney dialysis treatments or transplants to remain alive. • Title XIX created federal–state partnerships for states to establish health insurance plans for low-income people, broadly called Medicaid. • A number of changes have been made through the years, as explained in the sections that follow.

4. 12.1 The Medicare Program Initial Structure • The original template for Medicare had a standard appearance for the time: • Hospital care would receive the highest priority, with coverage beginning from the moment a person entered the hospital (“first-dollar” coverage). • Physician care would be paid under a “major medical” concept, with an initial deductible to accrue annually, a coinsurance provision to help control costs, and a “usual, customary, and reasonable” fee schedule to set provider fees. • Two parts: • Part A paid for services provided by hospitals. • Enrollment in Part A was mandatory for every person receiving Social Security benefits. • The entire cost of Part A is paid by the Medicare Trust Fund, a separate government account funded by general (income tax) revenues and earmarked (“Medicare tax”) additions to each worker’s current-year Social Security tax. • Part B (covering physician services), called Supplemental Medical Insurance,was made voluntary, although the premiums paid by enrollees were so low that enrollment has been very nearly 100 percent from the beginning of the program.

5. 12.1 The Medicare Program Initial Structure, continued • The program’s planners had little idea how much the program would actually cost, but they intended the Part B premium charged to enrollees to cover about half of the Part B program costs, in order to get the largest possible enrollment. • By current law, the basic Part B premium is intended to cover 25 percent of the program’s cost, the remaining 75 percent coming from general tax revenues. • In 2017, the basic premium was set at $134 per month per enrollee. • Beginning in 2010, Congress established a sliding income scale for Part B premiums, so that individuals with $85,000 or less income (twice that for families filing joint returns) pay the basic premium, and as incomes rise, so does the Medicare premium. • The upper payment level (for individuals with incomes above $214,000, twice that for families filing jointly) is $428.60 per month, over triple the basic amount.

6. 12.1 The Medicare Program Hospital Care • In its initial design, Medicare Part A paid for hospital care in the following way for each episode of illness of the patient: • Day 1: Patient pays U.S. average cost of hospital care. • Days 2–60: Medicare pays 100 percent of hospital charges. • Days 61–90: Patient pays 25 percent of average U.S. cost per day; Medicare pays the remainder. • Days 91–150: Patient pays 50 percent of average U.S. cost per day, drawing down a “lifetime reserve” of 60 days. • Day 151 and beyond: Medicare pays nothing. • The first-day “deductible” cost for hospitalization tracked directly with average hospital costs until 1987, at which point Congress set it at $520 and established a different formula for its update. • Since then, changes in the Part A deductible have closely tracked overall changes in the CPI, so (for example) by 2017, the Part A deductible had reached $1,316, moving closely with the CPI. • From an economic viewpoint, structure is completely “upside down” because it provides nearly “first-dollar” coverage but offers no serious protection against “catastrophic” financial risks.

7. 12.1 The Medicare Program Physician Care • The Part B coverage of Medicare includes a much broad range of services, but the great majority of Part B benefit payments occur for physician services. • Under the structure of the initial plan, Medicare paid for doctor services with a very traditional insurance model, encompassing a $50 annual deductible, a 20 percent coinsurance rate, and a fee schedule by which providers would be paid. • Congress increased the annual deductible to $60 in 1973, to $75 in 1982, and then to $100 in 1991. • The original Medicare Part B deductible was $50, and irregularly increased to $100 for 1991–2004, $110 for 2005, and then in proportion to the rate at which the average costs of treating Medicare Part B patients increased. • The new law (in effect) keeps the deductible a constant proportion of average Part B spending into the future, which means that it is increasing faster than the CPI in general. • The 2017 Part B deductible was set at $183, 66 percent higher than the 2005 value of $110. The CPI rose over the same period by 28 percent, so the Part B deductible increased at triple the rate of inflation over this 12-year period. • If the original Medicare law had specified that the deductible was indexed to the CPI, the original $50 would equal to $383 in 2017, almost eight times the original amount, so the current deductible is still t less than half of what it would have been with CPI adjustment.

8. 12.2 Economically Appropriate Deductibles • The proper way to set deductibles depends on the degree of risk aversion for a “representative individual” in the Medicare program (see Chapter 10). • Suppose first that the initial deductibles of $40 for the first day in the hospital in the Part A program and the $50 per year deductible for Part B were correct. • Then they should be indexed to the overall CPI to reflect the effects of general inflation. • The “real buying power” of the deductibles should remain the same from year to year. • The overall CPI has increased by a factor of 7.67 between 1965 and 2017, so by this logic the proper deductibles should be about $307 for Part A and $383 for Part B. • Could also examine the economically efficient coinsurance for hospital care using the type of model described in Appendix B to Chapter 10. • If the optimal coinsurance for hospital care is about C = 0.05, then we can compute the optimal copay for a typical hospitalization in Medicare. • The average Medicare cost per hospitalization is now about $15,000, so 5 percent of that would suggest a per-hospitalization copay of about $750 per hospitalization, about half of the current amount.

9. 12.3 Program Additions Through Time Medicare Advantage • In 1997, as part of the Balanced Budget Act (BBA), Medicare extended the ways people could enroll in various HMO plans. • Medicare Advantage allows eligible members to enroll in various private insurance plans in lieu of using standard Medicare coverage. • These plans must cover at least the same services that Medicare covers, but they need not cover them in exactly the same way. • The most common of these choices is the Medicare HMO, a “classic” capitation insurance plan as described in Chapter 11. • Medicare Advantage is essentially a voluntary voucher plan. • Enrollees continue to pay their appropriate Part B premium, and Medicare pays the private insurance plans using funds from the Part A and Part B pools, who in turn provide health insurance coverage to enrollees, commonly for no additional monthly fee, sometimes at small monthly charges such as $50 per month. • These plans commonly cover prescription drug costs as well, matching Part D insurance coverage, obviating the need for an enrollee to purchase a separate Part D plan. • As shown in Figure 12.1 (next slide), enrollment began modestly and then declined until 2005. • Enrollment then accelerated, now reaching almost one-third of all Medicare enrollees, and is likely to continue to grow as enrollment rates are higher among new enrollees (those just becoming eligible) than older enrollees.

10. 12.3 Program Additions Through Time Medicare Advantage • The 1997 BBA legislation named the program Medicare + Choice (commonly M + C), and it officially became Part C of Medicare (beyond the Part A hospital coverage and Part B physician coverage plans). • The name changed again in 2003 legislation to Medicare Advantage.

11. 12.3 Program Additions Through Time Risk Adjustment • When Medicare Part C was created in 1997, the payment to Medicare HMOs used an average adjusted cost per case, but the adjustments employed only two factors: regional differences in costs and demographic mix of the enrollees (age and sex). • The BBA of 1997 required that a more refined risk-adjustment measure be phased in beginning in 2000. • Before risk adjustment began, patients enrolling in Medicare HMOs actually increased total program expenditure because the HMOs were paid essentially an average cost per enrollee while treating patients with better than average health. • When the initial risk adjustment began in 2000, Medicare capitation payments to the plans fell by significant amounts. • Some Medicare HMOs left the industry and enrollment fell (see Figure 12.2, next slide) as new payment rules were implemented • As Medicare realigned the risk-adjustment methods in 2004, enrollment in the Medicare Advantage plans again began to increase. • Now more than 12 million participants (of 44 million Medicare enrollees).

12. 12.3 Program Additions Through Time Risk Adjustment, continued. • Figure 12.2 has three distinct time periods. • In the first period (1999–2000) without risk adjustment, Medicare overpaid the HMOs (which happily competed for enrollment among Medicare beneficiaries). • In the second time period (2000–2004), during which the initial risk-adjustment system was operational, payment to Medicare HMOs fell, some plans withdrew (the number of plans offering Medicare HMO services fell from more than 400 to fewer than 250), and enrollment plummeted from about 7 million to about 5.3 million in 2003. • In 2004, the beginning of the third period, Medicare shifted to a more refined adjustment system, and rapid entry into the field occurred, with enrollment increasing from 5.3 to 8.3 million people.

13. 12.3 Program Additions Through Time The Supplemental Children’s Health Insurance Program (SCHIP) • Medical interventions for children often have among the lowest cost per quality-adjusted life-years of any known medical interventions. • Of particular concern were children in families with incomes too high to qualify for Medicaid but nevertheless with low access to private health insurance, a group often called tweenersin policy discussions. • The Supplemental Children’s Health Insurance Program (SCHIP) legislation was enacted in 1997 (as part of the BBA) to help bridge this gap. • Ten-year horizon and authorized a total of approximately $40 billion for federal contributions, after which a refinancing bill was required in 2007. • SCHIP operates as a federal–state partnership, with each state designing its plan and the federal government setting ground rules and assisting in the financing. • States pay an average 30 percent of program costs, and the federal government pays the remainder, but requires a higher sharing rate for states with high per capita income.

14. 12.3 Program Additions Through Time The Supplemental Children’s Health Insurance Program (SCHIP), continued. • Under the 1997 legislation, states have three ways to improve coverage for children in this “tweener” group. • Each state can provide SCHIP through its Medicaid program, establish a wholly new SCHIP program, or use a combination of the two. • Because of this three-pronged approach, a meaningful assessment of SCHIP’s success or failure cannot be made on its own but can be assessed indirectly by measuring the numbers and rates of uninsured children in the U.S. before and after the program’s creation. • However, the program has eliminated less than one-third of the uninsured children in the country. • Before the ACA, the U.S. had about 73 million children in the under-18 age group, with about 15 percent of that population uninsured, and the steady-state level of about eight million uninsured children represent about 11 percent of the relevant population. • Also, the number covered by both Medicaid and SCHIP increased.

15. 12.3 Program Additions Through Time The 2007 Reauthorization Battle: Substitution and Crowding-Out • The political debates in 2007 regarding inclusion centered in many ways on the extent of crowding out,the situation in which the availability of public insurance programs reduces the demand for private insurance. • Expanding the income eligibility for SCHIP would clearly increase the extent of crowding out by SCHIP for private insurance. • The debate in part centered on “how much,” which in turn hinged on the nuanced difference between substitution and crowding out. • By usual definitions, substitution means dropping private coverage immediately when public coverage is acquired. • One study of the NY SCHIP program (Shone et al., 2008) based on interviews with SCHIP enrollees found that only 7.5 percent of SCHIP enrollees had actually given up private insurance when they enrolled in SCHIP.

16. 12.3 Program Additions Through Time The 2007 Reauthorization Battle: Substitution and Crowding-Out, continued. • Crowding out encompasses a wide set of behaviors, including direct substitution as well as anything else that reduces the use of private insurance. • A person might change jobs from one employer who offered insurance coverage for children (higher benefits and lower wages) to another who offered higher wages but not the good benefit of insurance for children. • The family then enrolls in SCHIP. • This change would be classified as a crowding-out event, not a substitution. • The Congressional Budget Office (2007) has estimated that “between a quarter and a half” of SCHIP enrollment in its first decade represented crowding out. • A recent analysis by Gruber and Simon (2007) that assessed crowding out more broadly indicates that crowd-out rates could be as high as 60 percent when entire families are considered, although their work does not apply directly to SCHIP.

17. 12.3 Program Additions Through Time The 2007 Reauthorization Battle: Substitution and Crowding-Out, continued. • Crowding out increases as the income-eligibility level increases for a program such as SCHIP. • When the 2007 reauthorization bill sought to increase the income from 200 percent (as originally written) to 400 percent (thereby doubling the income at which families would be eligible), the crowding-out issue became central. • One analysis (Winfree and DeAngelo, 2007) estimated that crowding-out rates would increase from 34 to 42 percent (in the under 200 percent of poverty group) to 54 to 60 percent in families with incomes between 200 percent and 400 percent of the federal poverty level. • To politicians, the crowding-out issue is often phrased in terms of “fairness” language (e.g., If wealthy people take advantage of programs designed to help the poor, is it fair?). • May also view this as a public sector versus private sector issue, an activity characterized by some as putting the government into competition with the private sector.

18. 12.3 Program Additions Through Time The 2007 Reauthorization Battle: Substitution and Crowding-Out, continued. • Economists often also consider the efficiency with which public programs achieve their stated goal. • Crowding out represents one form of inefficiency, but paying for things people would purchase on their own, and the federal income tax subsidy to private health insurance provided through employment groups also create inefficiencies. • The debate often hinges on whether the subsidy creates an incentive to change behavior on the margin or is (in contrast) inframarginal, in which case incentives do not change. • Compromise legislation that extended SCHIP for three years with previous rules about eligibility was finally passed and signed in late 2007. The PPACA extends SCHIP authorization through 2015.

19. 12.3 Program Additions Through Time How Part D Functions • Part D was designed to balance offering usable insurance coverage and controlling federal spending within the Medicare program. • The program offers catastrophic protection to persons with very large annual drug expenses, but not to people with intermediate to large expenses. • Part D began with an unusual insurance design, wherein enrollees had strong coverage for initial expenses, then a “donut hole” where coverage vanished, and finally, protection against very large annual drug expenditures (“catastrophic risk”). • The ACA phased in a new design for Part D plans that appears at this writing to remain a permanent feature of Part D, so we can most fruitfully consider how the new design works and how it will evolve in the next few years:

20. 12.3 Program Additions Through Time How Part D Functions, continued. • Basic plan structure in 2017: • Initial deductible: $400 • Between deductible and initial coverage limit: 25 percent of drug costs • Initial coverage limit (beginning of the donut hole): $3,700 • Out-of-pocket threshold (end of donut hole): $4,950 • Catastrophic cap payments: 5 percent of price for all drugs. • The ACA put in place a phasing out by 2020 of the donut hole. • After that enrollees will pay 25 percent of drug costs above the deductible, and then reach the catastrophic cap after the pre-set total out-of-pocket spending has been met. • Part D plans are all administered by private insurance companies under federal guidelines, and the premiums vary by region (due primarily to variations in prescribing patterns across regions).

21. 12.3 Program Additions Through Time Private Supplements to Medicare: “Medigap” Insurance • About 12 million Medicare enrollees subscribe to private supplemental plans, “Medigap”, to supplement their Medicare coverage. • As Medicare Advantage plans grow in enrollment, Medigap coverage correspondingly shrinks, since Medicare Advantage enrollees are not permitted to buy Medigap plans. • The word Medigap implies (correctly) that Medicare coverage leaves some large holes or gaps in the spectrum of coverage. • The hospital coverage under Part A creates some risk by providing increasingly less coverage for long hospital stays, and eventually an individual who has a very long hospital stay can actually run out of coverage. • In addition, individuals can face large daily copayments even with hospital stays as short as 61 days of a single hospitalization, higher ones after the 90th day, and even higher ones after the 120th day. • Part B also creates some significant risks, most notably with the open-ended 20 percent copayments for physician and surgeon fees. • While the introduction of Part D resolved some of the financial risk issues relating to prescription drugs, its structure has the large donut hole where drugs are not covered, an issue of particular concern for individuals with chronic illnesses who need regular and expensive drug treatments.

22. 12.3 Program Additions Over Time Private Supplements to Medicare: “Medigap” Insurance, continued. • Medigap policies “fill in the gaps” through private insurance contracts and often have a complex array of choices. • Medicare originally defined ten standardized plans (labeled Plan A, … Plan J), all of which “picked up” the Part A and B deductibles and copayment to some degree with plans that pick up some percentages (50, 75, 100) of uncovered costs. • Two new standardized plans (K and L) offer more limited coverage initially but eventually have a “stop-loss” feature that limits out-of-pocket expenses for covered individuals (in 2012) to $2,330 for Plan L or $4,660 for Plan K. • The annual premiums for Medigap policies vary not only according to the plan chosen but also to the region of the country because of differences in medical practice patterns and expenses incurred by enrollees. • According to one survey of Medigap premium costs, the average across the nation in 2005 ranged from about $1,150 to about $1,750 for plans without prescription drug coverage, with striking differences across regions. • The key issue involving Medigap is the underlying risk remaining within the standard Medicare program. • If basic Medicare contained good stop-loss provisions, few people probably would buy Medigap insurance. • And, because Medicare HMO plans create the stop-loss function through other mechanisms, researchers have found that higher Medigap premiums in a region lead to more Medicare HMO enrollment.

23. 12.4 Operational Changes in Medicare Limitations on Fees • A broad dispersion of fees generally prevails in a single geographic area, creating a problem for insurance carriers. • At its inception in 1965, Medicare paid for doctor services using the concepts of customary and prevailingfees. • Customary refers to the fee at the 50th percentile of the distribution of fees each doctor charges, so half of each doctor’s fees lies above and half below that doctor’s customary fee for a given procedure. • Prevailing is a concept that locates each doctor’s fee within the overall fee distribution in the community. Medicare used the 75th percentile in the distribution of fees within the community to define prevailing. • If the doctor’s customary fee exceeded the prevailing fee for the same service, Medicare paid only the prevailing fee. • Changed in 1971 when President Nixon instituted economy-wide price controls. • While soon lifted for the remainder of the economy, two sectors—petroleum and health care—remained controlled, with ongoing limits on the rate at which fees could increase. • Changes in the “prevailing fee” screen in each region of the country were limited to changes in the Medicare Economic Index, a weighted average of overall inflation, changes in the costs of physicians’ practices, and changes in the overall earnings level of the country. • Under the Omnibus Deficit Reduction Act of 1984, physicians’ fees were frozen again until the beginning of 1987, at which time a series of rules allowed some doctors to increase their fees somewhat, while placing very strict limits on others.

24. 12.4 Operational Changes in Medicare The Prospective Payment System • Beginning in October 1983, Medicare changed the way it paid hospitals for care delivered to patients. • Old system had paid hospitals on the basis of activities performed for each patient: an hour of operating room time, five physical therapy visits, etc. • The new approach, phased in over a four-year span, began to pay hospitals on a per-case basis rather than a per-item or per-service basis. • For the first time, doctors and hospitals treating individual patients were confronted with a fixed budget for the care of each patient. • With the old-style insurance, Medicare patients would exhibit a demand curve that was nearly price inelastic (see Chapters 8 and 9). • The prospective payment system (PPS) essentially offered a fixed price per hospital episode to the hospital, which would result in a perfectly elastic demand curve, as for a price-taking firm. • The hospital would pick the quality such that the demand curve was tangent to an AC curve, and this would define the quality of the hospital’s offering. • By setting prices in this way, the PPS system at least potentially forces hospitals to operate efficiently (at minimum AC), and it determines the quality of care by the level of price offered.

25. 12.4 Operational Changes in Medicare The Prospective Payment System, continued. • The prices actually offered by Medicare come from a system known as diagnosis-related groups (DRGs) that assigns each patient admitted to the hospital to one of a fixed number of groups. • The payment for a patient within any DRG varies somewhat by region and hospital type (e.g., teaching or nonteaching), but from the hospital’s point of view, the price per admission is fixed. • The hospital in most cases receives the same revenue from Medicare no matter what is done to the patient during the hospital admission or how long the patient stays in the hospital. • The largest change to the DRG system came in 2005, when CMS replaced the common pairings of DRGs relating to the presence of complications (e.g., Disease X, Disease X with complications) with a three-level staging of complications. • This new system, known as the Medicare-Severity DRGs (MS-DRGs), now numbers 757 different categories in 2017. • Previously, the doctor could undertake any procedure or prescribe any service or device that might benefit the patient, but now the hospital may lose money, because additional treatments may not generate additional revenue.

26. 12.4 Operational Changes in Medicare The Prospective Payment System: Length-of-Stay Effects • The most obvious dimension of adjustment for the hospital and its doctors is to shorten length of stay (LOS) for patients. • Easy to monitor and review. • Guidelines on LOS are easy to develop and interpret. • We have good reason to believe that if the hospital’s medical staff can find a way to coordinate doctors’ behavior,LOS would fall in response to the DRG incentive. • Data from CMS (see Figure 12.4, next slide) show the remarkable declines in LOS among Medicare recipients. • Figure 12.4b dissects the overall “hospital-days” measure into its two components, LOS and hospital discharges.

27. 12.4 Operational Changes in Medicare The Prospective Payment System: Length-of-Stay Effects

28. 12.4 Operational Changes in Medicare The Prospective Payment System: Length-of-Stay Effects • The PPS arrived just at the time when outpatient (one-day) surgery began to become technically feasible, in a combination of hospital ambulatory surgical (“ambi-surg”) centers, free-standing centers, and (for some procedures) doctor’s offices, all generally classified as “ambulatory surgical centers” (ASCs). • One of the most notable examples occurred in the realm of lens procedures (cataract surgery), a very common surgical procedure for the elderly. • Cataract surgery has two coincident features that made for the perfect storm for hospitals when PPS arrived. • First, it is not really an emergency procedure, and can be timed at the discretion of the doctor and patient. • Second, it is a simple and safe procedure that can be performed without the full array of hospital support services. • Half of the large spike in hospital discharges pre-1983 (from 300 per 1,000 enrollees to 390 per 1,000) came from a burst of in-hospital “lens procedures.” • Then, after the PPS system came into effect, a stampede occurred with an almost universal shift in the procedure to ambulatory settings (which do not count as hospital admissions, even if performed in the hospital itself, since the patient is discharged on the same day of admission).

29. 12.4 Operational Changes in Medicare The Prospective Payment System: Use of Other Services • One reason why doctors were able to adjust the LOS for their patients is because of substitution. • In the first three years of the Medicare PPS system, use of skilled nursing facilities (SNFs), a standard Medicare benefit, increased by 5.2 percent, 12.8 percent, and 5 percent, respectively, for a combined increase of 23 percent. • Use of home health care, another standard benefit, increased by even more during the same period. • Medicare added a temporary benefit for hospice care in 1983 and made it permanent in 1986. • This provides a low-technology “caring” environment for dying patients as an alternative to dying in the intensive care unit of a hospital (at the other extreme). • Hospices emphasize supportive services such as home care; pain control; and psychological, social, and spiritual services rather than attempts to cure the patient. • Hospice services have increased at a high rate since Medicare began coverage of this service. • Hospital care has two important substitutes: ambulatory surgery (over a wide range of procedures) and hospitalization and hospice care (end-of-life substitute for inpatient hospitalization).

30. 12.4 Operational Changes in Medicare The Prospective Payment System: Sicker and Quicker? • There was much initial concern that programs implemented by Medicare would have bad effects on patient health. • The Prospective Payment Assessment Commission (ProPAC), set up by the government, spent considerable effort documenting what effects, if any, the shorter stays generated by PPS might have on patients’ health. • One indicator of poor outcomes for patients is the rate at which they are readmitted to the hospital. • The rate of readmission to the hospital within 30 days, a standard indicator of “poor outcomes,” is about the same under PPS as in the previous five years. • Another indicator of poor outcomes for patients is mortality. • Particularly because of the incentives to discharge patients early, a common measure of mortality is the death rate within 30 days of a hospital discharge. • Can be difficult to compare over time due to changes in technology and the increase in the age of the Medicare population. • Holding these factors constant, the mortality outcomes during the first years of the PPS are completely consistent with the belief that no change occurred in mortality due to the PPS.

31. 12.4 Operational Changes in Medicare The Prospective Payment System: Sicker and Quicker? • A separate analysis of mortality rates within selected disease categories shows the same general result (Kahn et al., 1992). • In five high-mortality disease categories (congestive heart failure, acute myocardial infarction, fractured hip, pneumonia, and stroke), mortality rates actually declined in a comparison of years just preceding and just following the introduction of PPS in three of the five disease categories, and was statistically unchanged in the other two. • The ALOS in the patients in these disease categories fell by 24 percent in the comparison, making the mortality results all the more remarkable. • While patients were discharged (on average) in less-stable condition, this did not result in worse mortality outcomes. It now seems that implementation of PPS did not create any systematic degradation in patients’ health and safety, despite the reduction in LOS. • The hospital cannot benefit financially by discharging patients and then readmitting them to collect a new DRG payment because if the readmission takes place within seven days, it is counted as the same spell of illness, and hence the hospital receives no new DRG payment.

32. 12.4 Operational Changes in Medicare The Prospective Payment System: Consequences for Hospitals • The idea of PPS was to put a financial squeeze on “expensive” hospitals and make them become more efficient while putting a stronger sense of market control into the industry. • Hospitals’ net revenue margins (as a percentage of total costs) had climbed steadily from 1970 through 1983, with a brief two-year dip in 1971–1972 as a result of the Nixon-era price controls. • Trend reversed itself in 1984, the first year of the PPS system, and continued through 1991, when hospital margins began to recover. • For the decade following the introduction of PPS, Hodgkin and McGuire (1994) calculated the year-by-year changes in hospitals’ “exogenous” costs (those outside the control of the hospital, by and large). • Three changes affected costs: changes in costs of goods and services the hospitals buy (wages, supplies, etc.), in hospitals’ productivity (a cost-reducing change), and in the mix of patients. • Estimated these cost changes to be in the range of 5.6–9.0 percent per year, while at the same time the Medicare payment structure to hospitals was augmented by values between 0 and 5 percent per year, averaging about 3 percent per year. • The consequent “squeeze” on hospitals led to the declining margins described earlier.

33. 12.4 Operational Changes in Medicare The Prospective Payment System: Consequences for Hospitals • One possible response of hospitals is to decrease “intensity of treatment,” not only through reduced LOS but also through other changes in treatment as well. • Studies show that intensity fell significantly for Medicare patients, and in fact began to fall at the very beginning of the phase-in of PPS, apparently as a cost-reducing measure in anticipation of the full force of PPS. • Improved per-case profitability from 1991 through 1997 came with improved operating efficiency from the U.S. hospital industry, as the responses to the PPS squeeze came into full force. • Costs per Medicare case had followed a steady uptrend from the inception of the PPS program until 1991, when suddenly costs per case flattened off and actually declined slightly in the early 1990s. • Medicare’s formulas for reimbursement did not keep up with this shift from the previous trend and continued to climb along the previous path. • The result was an improving profit margin on Medicare cases that peaked in 1997 at about a 17 percent margin.

34. 12.4 Operational Changes in Medicare The Prospective Payment System: Consequences for Hospitals • This profitability, combined with a steadily degrading fiscal position of the Medicare Trust Fund, led the U.S. Congress to respond with the 1997 BBA, which “recaptured” the improved profitability of U.S. hospitals for the Medicare Trust Fund, and drove operating margins of many hospitals back into the red in a few brief years. • Hospital occupancy rates fell throughout the country, from pre-PPS levels of about 72 percent (national average) down to less than 65 percent. • Admissions fell about 6 percent in 1984 and about 10 percent in 1985, and then stabilized at that new level.

35. 12.4 Operational Changes in Medicare The Prospective Payment System: Consequences for Hospitals • The strong relationship between size and loss of patients emphasizes the nature of patients for whom this type of substitution is possible. • Small hospitals typically carry out procedures that are relatively uncomplicated, and therefore these hospitals are much more susceptible to competition from ASC-like organizations. • The PPS system may have contributed somewhat to the growth of the ASCs, but at least some of the economic hardship facing small hospitals comes from other directions than the PPS itself.

36. 12.4 Operational Changes in Medicare The Prospective Payment System: Consequences for Hospitals • The strong relationship between size and loss of patients emphasizes the nature of patients for whom ambulatory surgery substitution is possible (Table 12.2). • Small hospitals typically carry out procedures that are relatively uncomplicated, and therefore these hospitals are much more susceptible to competition from ASC-like organizations. • The PPS system may have contributed somewhat to the growth of the ASCs, but at least some of the economic hardship facing small hospitals comes from other directions than the PPS itself.

37. 12.4 Operational Changes in Medicare The Balanced Budget Act of 1997 • The BBA was passed in response to increased hospital profitability and growing Medicare costs. • The essential feature of the BBA was a shift from planned increase in hospital reimbursement rates to significant reductions for a few years, with an intended “leveling-off” after a large bite had been taken out of the system. • Specified that the rates of increase of PPS payments for 1998 through 2002 would be below the cost index, allegedly returning to cost index levels in 2003. • Cumulative effect was a set of hospital payments under Medicare that were 5.6 percent lower than they would otherwise have been. • Goal was to cut the annual rate of increase in total Medicare expenditures from 8.8 percent (the baseline estimate of what to expect) to 5.6 percent. • In fact, the annual growth rate from 1998 forward has been only 3.9 percent, partly due to the cuts made in payment rates and partly due to other cost-cutting moves by hospitals. • The payment reductions caused by the BBA greatly increased the financial problems of many hospitals in the United States. • In response, Congress amended the BBA in 1999 with the Balanced Budget Refinement Act (BBRA), adding back $11 billion in payments for the 2000–2002 period. This restored about 10 percent of the initial revenue reduction set out in the BBA.

38. 12.4 Operational Changes in Medicare Physician Prospective Payment • Congress authorized the formation of the Physician Payment Review Commission (PPRC) in 1986 to provide recommendations about altering the way Medicare pays physicians. • Resource-Based Relative Values (RBRVS) • Harvard University’s School of Public Health in late 1988 developed a series of relative values of various procedures performed by physicians and surgeons, called the resource-based relative value system (RBRVS). • The underlying logic of the method used by the RBRVS study was to produce what might be called “equal pay for equal work,” or to pay physicians according to the time and complexity of their effort equally, whether the task at hand was neurosurgery, psychiatric consultation, or removal of warts. • Drew the distinction between “invasive procedures” and “evaluation and management” (E/M), which corresponds (imperfectly) to the distinction between practice styles of surgeons and internists (respectively).

39. 12.4 Operational Changes in Medicare • Resource-Based Relative Values (RBRVS), continued. • The study’s authors applied their relative values to actual dollar charges and simulated the effects of using their payment plan, holding total Medicare outlays unchanged. • Assumes that the mix of services provided to patients in the long run remains unchanged. • Fees for many surgical procedures would fall by one-third to one-half. Fees for “cognitive” (E/M) services would rise by comparable percentages. • According to their simulations, overall Medicare outlays for E/M services would rise by 56 percent and for invasive procedures would fall by 42 percent. • Laboratory payments would fall by 5 percent, and fees paid for imaging (X-rays, CT scans, MRI scans, etc.) would fall by 30 percent. • The RBRVS has been fully implemented since 1996. • Studies have shown results along the lines of expectations, with generalists faring about as well as predicted, and surgeons declining, but not by as much as expected. • Generalists: cumulative increases, 1991-1997, 36 percent in average Medicare payment rates compared with the Harvard study’s pre-implementation estimates of 39 percent. • Surgery-intensive specialists did not fare as poorly as predicted in part due to successful lobbying for special treatment in the implementation phase of the RBRVS.

40. 12.4 Operational Changes in Medicare Episode-of-Illness-Based Payment Plans (Physician DRGs) • Might be possible to pay for physicians on an DRG-like system. • Episode of illness rather than payment per service. • But this requires well-defined episodes, only one economic agent, and the DRG system to be accountable for much of the variation in costs, all of which are true for hospitals. • In ambulatory care, there often are not clearly defined episodes with a beginning and end. • More than one physician may care for a patient within an episode of illness, which complicates things because the DRG payment should apply to the illness, not the doctor. • For hospitals, the system of DRGs does not leave the hospital, so there is not much within-group variability in cost of treating patients; this is not the case outside the hospital setting. • With all these complications, the difficulty of even defining a DRG system for doctors has deterred any real study of the method.

41. 12.4 Operational Changes in Medicare Time-Based Payments (Capitation) • An alternative payment plan would use physician payments that were wholly prospective, no matter what the condition of the patient—a per-year “capitation” system. • Capitation provides, in many ways, the strongest incentives for controlling costsbut imposes a large financial risk on individual providers (at least in its pure form). • Prepaid group practices get around this problem by enrolling large numbers of individuals and families—tens to hundreds of thousands of enrollees per plan. • With enrollments per plan on that order, the law of large numbers begins to protect the plan with regard to overall variance of expenses because the variance in expense per member falls with the number of enrollees. • However, with a single physician’s practice, enrollees number only in the hundreds, and the financial risk that a pure capitation plan imposes on the physician is considerable. • A “pure” capitation plan would put the primary-care physician at risk for all health care expenses of the patient, or at least all nonhospital expenses.) • Some sort of risk sharing would be necessary.

42. 12.4 Operational Changes in Medicare Time-Based Payments (Capitation), continued. • The Part A DRG plan already includes a “stop-loss” provision for the hospitals for each hospital admission. • If any patient’s LOS exceeds certain bounds (different for each DRG), the patient is declared an “outlier,” and the hospital begins to be paid on a per-unit basis. • Proposals to use capitation within Medicare for physician payments typically speak of capitation payments to insurance plans rather than to individual physicians. • The most recent addition is the advent of accountable care organizations (ACOs), discussed in Chapter 15. • The ACO allows continued payment in an FFS mode, coupled with “shared savings” when costs of treatment are lower than for comparable patients in standard treatment settings for Medicare patients. • Encouraged to adopt a different financing model where the revenue streams of each set of providers are combined into a single revenue source for the umbrella ACO, at which point the model closely resembles a capitation model.

43. 12.5 The Medicaid Program Introduction • Enacted in 1965 with the original Medicare legislation, Medicaid has an entirely different purpose and structure than Medicare. • State–federal partnership with each state designing its own program within federal guidelines and with the federal government sharing the program costs. • The sharing formula provides a larger federal share for states with low per capita income, the federal share ranging from 50 to 75 percent. • Medicaid has income limits for eligibility; it is the health insurance program for the poor. • Eligibility usually hinges on the FPL multiplier as published annually by the Bureau of the Census for families of different sizes and used by each state. • Covers almost all types of health care for enrollees and some that Medicare does not. • Medicaid covers nursing home care indefinitely for eligible citizens. • Multiple dimensions of Medicaid programs differ across states: who is eligible, what services are covered, and how providers are reimbursed. • Budget control efforts have caused many states to offer very low fees to providers for treating Medicaid patients, thus often limiting the range of options for Medicaid enrollees.

44. 12.5 The Medicaid Program Who Is Covered • Medicaid legislation requires that anybody within a state who is eligible for income assistance is also eligible for Medicaid. The Medicaid program summarizes the “mandatory” eligibility for each state’s program as follows: • Those who meet the requirements for the Aid to Families with Dependent Children (AFDC) program in effect on July 16, 1996. • Fewer than six children if a family’s income is more than 133 percent of the FPL. • Obstetric services for pregnant women with family income of more than 133 percent of FPL. • Supplemental security income (SSI) recipients in most states. • Adoption/foster care recipients under Title IV of the Social Security Act. • Specially protected groups (typically individuals who lose their cash assistance due to earnings from work or from increased Social Security benefits but who may keep Medicaid for a period of time). • Children less than 19 years old born after September 30, 1983, with family income less than the FPL.

45. 12.5 The Medicaid Program Who Is Covered • Medicaid legislation requires that anybody within a state who is eligible for income assistance is also eligible for Medicaid. • The Medicaid program summarizes the “mandatory” eligibility for each state’s program as follows: • Those who meet the requirements for the Aid to Families with Dependent Children (AFDC) program in effect on July 16, 1996. • Fewer than six children if a family’s income is more than 133 percent of the FPL. • Obstetric services for pregnant women with family income of more than 133 percent of FPL. • Supplemental security income (SSI) recipients in most states. • Adoption/foster care recipients under Title IV of the Social Security Act. • Specially protected groups (typically individuals who lose their cash assistance due to earnings from work or from increased Social Security benefits but who may keep Medicaid for a period of time). • Children less than 19 years old born after September 30, 1983, with family income less than the FPL.

46. 12.5 The Medicaid Program Who Is Covered, continued. • Medicaid legislation requires that anybody within a state who is eligible for income assistance is also eligible for Medicaid. • The Medicaid program summarizes the “mandatory” eligibility for each state’s program as follows: • Those who meet the requirements for the Aid to Families with Dependent Children (AFDC) program in effect on July 16, 1996. • Fewer than six children if a family’s income is more than 133 percent of the FPL. • Obstetric services for pregnant women with family income of more than 133 percent of FPL. • Supplemental security income (SSI) recipients in most states. • Adoption/foster care recipients under Title IV of the Social Security Act. • Specially protected groups (typically individuals who lose their cash assistance due to earnings from work or from increased Social Security benefits but who may keep Medicaid for a period of time). • Children less than 19 years old born after September 30, 1983, with family income less than the FPL. • Many states have more generous definitions of poverty. • Nationally, about 20 percent of the population is typically enrolled in Medicaid.

47. 12.5 The Medicaid Program What Is Covered and How? • Federal rules require that Medicaid cover standard health care services, both inpatient and outpatient, including a wide array of preventive activities (both vaccinations and screening examinations), prenatal care, laboratory and diagnostic imaging, and nursing home services for adults, and specified others. • Most of the state plans cover more than the minimum services, commonly adding prescription drugs, prosthetic devices, optometrist services, rehabilitation services, nursing home services for children, and a wide array of diagnostic services. • Programs that cannot have any cost sharing are those for pregnant women, children under age 18, patients in a hospital or nursing home who are expected to contribute most of their income to institutional care, and individuals using emergency and family planning services. • Other programs may have cost sharing provisions. • New York’s cost-sharing program, for example, charges $3 per clinic visit, nothing for a private physician visit, $3 for an emergency room visit, $1 for X-rays, $0.50 for lab tests, $3 for top-tier drugs, $1 for generic drugs, and $25 for the last day of hospitalization.

48. 12.5 The Medicaid Program How Is It Financed? • The Federal Medical Assistance Percentage (FMAP) primarily finances Medicaid. The program compares each state’s average PCI with the national average, which is determined annually by using a predetermined formula. • By law, the rate cannot go below 50 percent of PCI or higher than 83 percent. • In recent years, 12 states received only 50 percent, the average was about 60 percent, and the highest was about 77 percent. • States’ decisions about program generosity (enrollment eligibility rules, breadth of services covered, and provider reimbursement) are based on both income and price effects, such as individual consumer budget decisions. • States with higher per capita incomes (PCI) tend to have more generous programs but also face higher prices for their Medicaid programs because the rules creating the FMAP cause the federal share to be lower. • The 1997 BBA created a permanent rate of 70 percent for the District of Columbia, and Alaska gets special consideration because of the unusually high cost of living in that state, which distorts the PCI number.

49. 12.5 The Medicaid Program How Are Providers Compensated and What Are the Effects on Access? • Medicaid pays most health care providers poorly. • Figure 12.5 (below) shows hospital payments as a percentage of hospital costs, by provider. • The data show that Medicare reimbursement has varied above and below 100 percent payment over the years but on average is only slightly below 100 percent. • Private payers (mostly those with private insurance, of course) pay well above 100 percent and average about 125 percent during the years on this chart. • Medicaid pays between 80 and 95 percent of costs, averaging about 90 percent through the years.

50. 12.5 The Medicaid Program How Are Providers Compensated and What Are the Effects on Access?, continued. • Physician compensation appears to be even lower (relative to Medicare) than hospital compensation. • Decker (2007) compared Medicaid physician compensation rates across the nation with comparable Medicare rates, showing that on average Medicaid rates are only about 65 percent of the Medicare rate for comparable activities (ranging from 55 to 75 percent through the years of her sample). • On average, only about 40 percent of all doctors accepted Medicaid patients in their practices, and the rates at which they did this varied directly with the generosity of fee schedules. • Medicaid patients had shorter visits with doctors (about 4 minutes, or 20 percent less time per visit on average) than patients with other insurance. • Medicaid’s compensation generosity affected the visit length in the direction we would expect: The nearer Medicaid came to Medicare compensation, the longer the visit for Medicaid patients. • Medicaid compensation for providers is uncommonly low, and that, in turn, affects access of low-income persons with Medicaid coverage to health care, both in terms of finding physicians who will treat them and the amount of time they spend in patient visits. • Medicaid has built in an extra payment—disproportionate share (DSH) payments—to those treating an unusually large number of Medicaid patients for their region.