A Small Step In The Right Direction

By H.E. Frech III and Kenneth L. Danger

The Senate's proposal to charge higher premiums for Part B (physician's services) insurance for higher income Medicare beneficiaries is a small step in the right direction. It recognizes reality: Medicare is a welfare program, part of the governmental safety net. The details of Medicare are not part of the social contract. Medicare can be changed and still provide high quality coverage and access, but at a lower cost. This is the social contract.

The Senate's action sets a useful precedent by changing something that's obvious to beneficiaries. Medicare has been treated as a political sacred cow, immune to serious reform, for too long.

Like the rest of Social Security, Medicare is primarily paid for by taxes on those currently working. What Medicare beneficiaries receive is unrelated to what they paid in the past. This means that Medicare doesn't follow insurance principles; it redistributes income in complex ways, some favoring the poor and some favoring the wealthy.

Perhaps unintentionally, the higher premiums for the wealthy will have good indirect effects on Medicare's benefit structure. Some of the wealthy will drop Part B and pick up private insurance instead. Competition will force these insurers to make intelligent use of copayments and managed care. Because the wealthy tend to be relatively big users of Medicare benefits, their defection may save money. Perhaps most important, the defection of some of the wealthy sets a good precedent for future reforms, increasing choice and pluralism.

But, even at best, the Senate's proposal will only delay Medicare's financial problems. In the long run, it will do little to change the fundamental structure.

The idea that rapid movement into efficient Health Maintenance Organizations (HMOs) will solve the problem is wishful thinking. Because the elderly often have valuable established relationships with physicians, they are reluctant to switch to traditional HMOs that don't include their physicians.

The key problem is that many Medicare enrollees have additional private Medigap or state Medicaid insurance. The Physician Payment Review Commission (PPRC) estimates that nearly 90 percent of Medicare enrollees are covered by this supplemental insurance which often covers the deductible, the 20 percent coinsurance and balance billing by the physician. In effect, many Medicare beneficiaries have nearly 100 percent coverage, without the utilization control or limited provider panels of normal managed care plans.

It should no longer be controversial that such complete coverage leads to high and wasteful utilization. Indeed, the effects of Medicare supplemental insurance coverage have been extensively studied by economists. Recently, the PPRC estimated that beneficiaries with private supplemental insurance consume 28 percent more care than those without it. Most of the extra utilization is paid for by Medicare, at an annual cost of about $1,000 per beneficiary.

The growth of these supplemental plans over the years has progressively destroyed the cost controls sensibly built into Medicare in the beginning. We are surprised that Congress has allowed this to happen.

Increased Medicare premiums will only slow Medicare's slide into bankruptcy. A more promising proposal by the Senate Finance Committee, dropped by the full Senate, was to increase the Medicare deductible for wealthy Americans. Adopting that proposal, or at least indexing the deductible to inflation, would slightly (but usefully) increase cost sharing. Indeed, in the last 30 years of Medicare the deductible has only been allowed to increase to $100. If it had been indexed to inflation, the deductible would be about $235 today. Medicare's design, never modern, has become more outdated over time.

While increasing the deductible is a useful part of reform, much more can be done. Sensible economic incentives need to be created.

First, Congress should first prohibit or sharply discourage private supplemental insurance coverage. Second, Medicare should be redesigned to improve catastrophic coverage (including drugs). Third, Medicare's managed care option should be expanded to include looser managed care plans, such as Preferred Provider Organizations (PPOs) or Point of Service (POS) plans. Such plans are more attractive than traditional HMO's, as they allow seniors to continue their established relationships with physicians. We would expect a rapid movement into PPOs and POS plans as a result of these reforms.

The Senate's minor reform should be applauded. It is a small step in the right direction and a good precedent. But, we urge Congress and the Clinton administration to take the bolder steps outlined above.

Large reforms in medical insurance have lead to equally large efficiency gains. When faced with a bankrupt Medicaid program, Tennessee promptly enrolled all of its Medicaid beneficiaries into HMOs, allowing an expansion of the program to 300,000 previously uninsured citizens. In a similar situation, California instituted competitive hospital contracting, saving hundreds of millions of dollars.

Frech is professor of economics at the University of California, Santa Barbara, and an Adjunct Scholar at the American Enterprise Institute. Danger is a Ph.D. student and a lecturer at the University of California, Santa Barbara.