by Kip Sullivan
Z magazine, September 2003
Republicans have publicly supported the
privatization of Medicare since they took control of Congress
in 1995. Democrats have supported adding drug coverage to Medicare
since 1999. In 2003, Republicans linked the issues.
President Bush announced last January
that he would support adding a scrawny drug benefit to Medicare
on the condition that Medicare beneficiaries be given financial
inducements to join HMOs, and on June 12 House Republican leaders
introduced a bill that adds scrawny drug coverage to Medicare
and puts great financial pressure on seniors to join HMOs beginning
in 2010. On June 27, the House passed the Republican bill by a
single vote. The bill must now be reconciled with a similar Senate
bill that also passed on June 27, which puts considerably less
pressure on seniors to enroll in HMOs.
The media has given the drug coverage
portion of this story extensive coverage and has done a good job
of reporting on Bush's campaign to hold drug coverage hostage
to his privatization plans. But the media has devoted very little
ink to explaining how privatization would work under the Bush
and House proposals. Worst of all, the mainstream media has made
no effort to represent the views of experts who believe HMOs cannot
possibly save Medicare money and might damage the quality of care.
The New York Times' coverage represents
the best and the worst of the media's coverage of the drug and
privatization issues. Last January, the Times was the first news
outlet to report that Bush intended to give the two issues high
priority in 2003. The article, which ran on January 3, made it
clear that Bush was seriously considering making seniors leave
the traditional Medicare program (where 89 percent get their coverage
now) and enroll in an HMO (where the other 11 percent are covered),
and that some Democrats were opposed to such a plan. The article
quoted the chief of staff of Rep. Pete Stark (D-CA) saying, "If
the price of a prescription drug benefit is the end of Medicare
as we know it, that's not a price worth paying. "
But the lengthy article gave no indication
that a substantial body of research demonstrates that the HMOs
that are now insuring seniors add to rather than lower Medicare's
costs. In fact, the article created the impression that HMOs were
lowering costs by describing HMOs as "more efficient [and]
less costly" than traditional Medicare, and by presenting
the HMO industry's claim that Medicare doesn't pay HMOs enough.
Two factors make it impossible for HMOs
to insure the elderly for less money than the traditional Medicare
program does: HMOs have overhead costs that providers (doctors
and hospitals) serving traditional Medicare patients do not incur
and that Medicare therefore does not pay for; and HMOs pay providers
more than traditional Medicare does.
HMO overhead expenditures, that is, their
payments for things other than medical care, equal about 20 percent
of total HMO revenues. The main categories of HMO overhead expenditures
are marketing, policing doctors, lobbying, obscene salaries and
perks for management, and profit for insurance company shareholders.
Under the traditional Medicare program, Medicare pays providers
directly; there is no HMO middleperson and, therefore, no HMO
overhead to siphon off 20 percent of Medicare's payments before
it reaches providers. But under the HMO portion of the Medicare
program, Medicare pays the HMO middlepeople and HMOs, in turn,
pay providers, but only after the HMOs have scraped off 20 percent
of their payments from Medicare to cover their overhead.
The evidence that HMOs have overhead costs
in the range of 20 percent of revenues comes from Wall Street.
On Wall Street, HMOs brag about their "medical loss"
ratios-the ratio of their medical expenditures (their payments
to providers) to their total revenues. An HMO loss-to-revenue
ratio of 70 percent is considered great for investors whereas
a ratio of 90 percent is considered abysmal. No one has calculated
the average medical loss ratio for the entire US health insurance
industry, but it's possible to do so for the largest insurers.
In 1999, the medical expenditures of today's four largest health
insurance companies (United HealthCare, Aetna, Cigna, and Wellpoint)
averaged about 80 percent of the revenues of these companies.
The existence of HMO overhead means that
HMOs have to reduce their medical costs by more than 20 percent
in order to save Medicare money. That's an enormous handicap.
But huge overhead is not the only HMO handicap. HMOs also pay
higher rates to providers than traditional Medicare does. The
New York Times was apparently the only major news outlet to report
this fact. Paul Ginsburg, president of the Center for Studying
Health System Change, recently told the Times, "In most areas
of the country, payment rates for hospitals and physicians that
are negotiated by private plans are higher than those paid by
the [traditional] Medicare ...program." According to the
Medicare Payment Advisory Commission, which advises Congress,
hospitals charge HMOs about 40 percent more than they charge Medicare
and physicians charge HMOs about 15 percent more. Together, these
differences in provider rates add another 20 percent to HMO costs.
Medicare's ability to pay lower fees is
due to its size. With 36 million people, traditional Medicare
is far and away the nation's largest insurance program. It's so
big and provides such a large portion of the average provider's
revenues that providers can't afford to walk away from the Medicare
When we add HMOs' higher overhead (20
percent) to their fee disadvantage (20 percent), we're looking
at a handicap equal to roughly 40 percent. HMOs have only two
ways to offset this enormous handicap: (1) they can deny much
more medical care to their patients than traditional Medicare
denies its patients; (2) they can seek to avoid the sickest patients
and enroll only the healthy. Neither strategy is morally or politically
The HMO industry's efforts to ration health
care in the nonelderly market backfired so badly in the mid-1990s
that the industry has begun to back away from its most aggressive
managed-care tactics. If the nation wouldn't tolerate aggressive
rationing by HMOs among the nonelderly, it would certainly not
tolerate even more aggressive rationing among the elderly.
That leaves the HMOs with only one strategy:
to enroll only the healthiest seniors-a tactic called cherry picking-but
get paid as if they were enrolling average seniors. At least two
dozen studies have demonstrated that HMOs have benefited from
this strategy for at least the last two decades. Congress has
been apprised repeatedly of this fact. The U.S. General Accounting
Office (GAO), the Congressional Budget Office, and the Medicare
Payment Advisory Commission have all sent reports to Congress
stating that Medicare is overpaying
Medicare HMOs by large amounts because
the HMOs attract disproportionately healthy seniors. The GAO reported
in 1999, for example, "studies conducted by us, ...the Medicare
Payment Advisory Commission. . . and others demonstrated that
the Medicare program spent more on beneficiaries enrolled in health
plans than it would have if the same individuals had been in [traditional
Medicare]. This unexpected result occurred because Medicare payments
were based on the estimated cost of... beneficiaries [in traditional
Medicare] in average health and were not adequately adjusted to
reflect the fact that plans tended to enroll beneficiaries with
better- than- average health.... "
The studies the GAO cited indicate the
Medicare overpayment to HMOs lies somewhere in the range of 15
to 45 percent. If this seems hard to believe, consider just one
of the studies the GAO was referring to-a study by the Physician
Payment Review Commission, a predecessor to the Medicare Payment
Advisory Commission. In its 1996 report to Congress, this commission
reported a study it had done which found that the seniors who
enrolled in Medicare HMOs were so healthy they cost the HMOs only
60 percent of the average cost of Medicare beneficiaries.
If we tack on another type of overpayment-this
one equal to about 5 percent of Medicare payments to HMOs-caused
by HMOs fraudulently inflating their administrative costs, a problem
documented by a 1998 report of the Department of Health and Human
Services, we may say Medicare has been overpaying the average
HMO by somewhere in the range of 20 to 50 percent. It is this
gigantic, unintended overpayment that makes it possible for some
HMOs to survive in the Medicare "market" despite big
handicaps-high overhead and relatively high provider payments.
Medicare HMOs may continue forever to
get away with inflating their administrative costs and inducing
Medicare to pay it (the Clinton administration showed, and the
Bush administration has so far shown, no interest in preventing
HMOs from padding their Medicare charges), but they can't continue
forever to cherry pick. Enrolling the healthiest of the Medicare
population is possible only as long as the HMOs enroll a tiny
proportion of that population. If and when HMOs begin to enroll
a growing proportion of the Medicare population, which is the
Republicans' goal, HMOs will find it more and more difficult to
avoid their share of the sick. As the HMO industry's share of
Medicare beneficiaries rises from its current level of 11 percent,
and as the typical HMO enrollee becomes more typical of the Medicare
population, the unintended cherry-picking subsidy to the HMOs
HMOs start out with two financial disadvantages
against traditional Medicare: (1) they generate administrative
costs equal to roughly 20 percent of their revenues; (2) they
pay higher provider fees equal to about another 20 percent. It's
conceivable that a pro-HMO Congress could eliminate the latter
handicap by simply ordering providers to charge Medicare HMOs
no more than they charge the traditional Medical program. But
even if Congress would do that over the objections of the physicians,
hospitals, and (if drug coverage is added to Medicare) the drug
companies, the HMO overhead problem would still remain. The HMOs'
two remaining weapons-rationing and cherry picking-will be nowhere
near potent enough to offset their overheads. Aggressive rationing
of Medicare beneficiaries by HMOs is not politically and morally
acceptable, and the HMO cherry-picking advantage will disappear
as privatization gradually brings a larger and larger portion
of the Medicare population into HMOs.
Privatization cannot save Medicare money.
Republicans should drop their privatization proposal and kick
the HMOs out of Medicare all together.
Kip Sullivan lives in Minneapolis. He
writes frequently about health policy.