The BBA’s goals with respect to Medicare Advantage can be summarized in the following question: Could Medicare Advantage be reformed so that Medicare could participate in the managed care dividend enjoyed by private employers? In the latter half of the 1990s, Republicans (the new congressional majority), centrist Democrats, and some policymakers began to look to Medicare as a source for reducing the deficit (Oberlander 2003
). Debate centered on the idea of “premium support,” in which Medicare beneficiaries would be given a lump sum—in effect, a “voucher”—that could be used to pay for a private plan or for the premium for TM, a model used by some private employers as well as the Federal Employees Health Benefit Program (FEHBP) (Oberlander 2000
). Aaron and Reischauer (1995)
, among others, argued that such a policy would promote competition and efficiency in Medicare, give beneficiaries a choice, and capture some of the managed care dividend for Medicare.
Moving Medicare to a defined-contribution model from a defined-benefit model would have profoundly altered its nature. In effect, it would have protected Medicare, meaning (mostly nonelderly) taxpayers, while possibly exposing beneficiaries to higher costs. Opponents worried not only about the possibly higher cost to the elderly but also about HMOs’ restrictions on access to specialists and reductions in inpatient care, which could have adverse effects on the elderly’s health. Critics pointed out that the elderly were a more vulnerable population than the privately employed and that inadequacies in the AAPCC’s risk-adjustment system would favor selection and the likely overpayment of private plans (Oberlander 1997
After an intense debate, Congress passed the BBA, in which Medicare’s at-risk contracting with health plans was formally designated as Part C of Medicare and named Medicare+Choice (M+C). The intent was to encourage competition and the growth of managed care in the Medicare program, with the hope that this would save Medicare funds. Most Democrats, however, vehemently opposed the defined-contribution initiative and succeeded in having the topic assigned to a bipartisan commission for study. In the meantime, Medicare remained a defined benefit program.
Following the private market’s lead, the BBA authorized new types of private plans within Part C: preferred-provider organizations (PPOs), provider-sponsored organizations (PSOs), and private fee-for-service plans (PFFS). PSOs are similar to HMOs except that they are run by a provider or a group of providers. PFFS plans were not managed care plans at all, but indemnity plans like traditional Medicare that were prohibited from having restrictive provider networks and from actively managing care at all. PFFS plans did however, serve to “privatize Medicare,” thus meeting a political objective of some conservatives. These plans initially arose from the desire of some physicians to be able to charge above the Medicare fee schedule (the idea was that the insurer would recoup these costs through the premium) and from pro-life supporters who (in our view, mistakenly) feared rationing in TM. Enrollment in PFFS plans, however, remained minuscule through 2003, when they were given “deeming authority.” This authority allowed the PFFS plans to pay traditional Medicare prices to providers participating in TM, thereby negating the hopes of those physicians who had advocated the PFFS option in order to avoid the restrictions of the Medicare fee schedule. Although PFFS plans are authorized under Part C of the program, they do not provide a markedly different delivery alternative to fee-for-service TM (but in many areas they had better benefits, for reasons described later). We will discuss them separately from the other risk-based MA plans (HMOs, PPOs, etc.).
The BBA also required the Centers for Medicare & Medicaid Services (CMS) (then called Health Care Financing Administration, HCFA) to improve its risk-adjustment methods by using measures of health status, which the agency began to implement in 2000 by including diagnosis as a risk adjuster. The idea was that MA plans would be paid more for sicker patients and less for healthier ones. For the first few years after 2000, however, only 10 percent of the plan payment was based on the enhanced risk-adjustment system, because before this time, only the diagnoses of inpatients were reliably coded, and so only hospital-based diagnostic data could be used in the new formula. (TM payments to hospitals were based partly on the diagnosis responsible for the stay, whereas payments to physicians did not depend on diagnosis and so was not reliably reported.) The CMS did not want to encourage plans to hospitalize a patient solely to record a diagnosis and to receive a higher reimbursement; hence, the new system was given only a modest 10 percent weight. To remedy this flaw, the BBA required the collection of diagnoses for outpatient claims, which were to be incorporated in a risk-adjustment system that used both inpatient and outpatient diagnoses. Such a system was implemented in 2004 and is discussed in the following section.
In response to geographic inequalities in Part C reimbursement, which reflected lower TM reimbursement in many rural areas, the BBA changed the payment formula for Part C plans. To encourage plans to enter areas with low AAPCC rates, the plans were paid the higher capitation rate of (1) a minimum, national floor payment that began at $367 per month in 1998 and was to be adjusted annually; (2) a 2 percent increase from the county’s prior year rate; or (3) a blended national and local payment, applied only when the impact on Medicare costs was neutral (which happened only in 2000). Thus changes in the plans’ payment to the county were no longer directly linked to changes in TM costs to the county, although the initially large differences in the level of reimbursement across counties were largely preserved. The floors, however, increased the health plans’ overpayment, because even if the selection into health plans were neutral, Medicare would be paying more for Part C enrollees in any floor county than it saved on spending in Parts A and B. This was, however, a time when Congress was trying to cut Medicare spending, so it was looking for some savings to offset the increased spending on the floor payments. It found these savings by effectively limiting to 2 percent the increases in Part C reimbursement in nonfloor counties. Since Part C costs were tied to TM costs and TM costs were projected to rise more than 2 percent, this resulted in a “scoreable” offset to the floor payments in the arcane arithmetic of federal budgeting.
To keep hospitals and doctors in their networks, however, the plans, including traditional Medicare, had to pay market rates. As a result, the 2 percent cap on payment increases in the nonfloor counties cut the plans’ margins in these counties, sometimes enough to turn the margins negative. To restore their profits, plans in these counties reduced the number of covered services, such as prescription drug coverage, and raised their cost-sharing requirements (Young 2003
). Consequently, the number of plan contracts began to drop from the high of 346 reached in 1998 (), and the plans withdrew from some counties that they had been serving.
In response to the plans’ actions, growth in enrollment in Part C plans slowed in 1997 and began to decline in 1999 (). By 2002, only 4.9 million individuals (12% of beneficiaries) were enrolled in a Part C plan, down from 6.3 million (16% of beneficiaries) in 1999. Between 1999 and 2003, more than 2 million beneficiaries were involuntarily disenrolled from those plans that withdrew from certain counties. Approximately 20 percent of them had no other Part C plan to choose (Gold et al. 2004
), which was a huge setback to the goal of expanding choice. By 2003, Medicare’s managed care penetration rates were greater than 15 percent in only ten states, and the penetration rates in all remaining states averaged only 4 percent, just half of what they were in 1999 (Gold et al. 2004
Caught short by the exodus of private plans after the BBA’s and beneficiaries’ complaints about involuntary withdrawals and benefit reductions, Medicare and Congress responded with a series of stopgap policies between 1999 and 2002 that attempted to stabilize the MA program. The basic strategy was simple: pay more.
Overall, the BBA, riding the tail end of the decade of managed care growth, succeeded in cutting the growth of Medicare spending, which in nominal dollars actually fell from 1997 to 1999, mainly because of large cuts in TM reimbursement to home health agencies and skilled nursing facilities. Such a fall in nominal Medicare spending had never happened before—and has not happened since. The improved fiscal situation allowed Congress to pass both the Balanced Budget Refinement Act in the fall of 1999 (BBRA) and the Budget Improvement and Protection Act of 2000 (BIPA), which raised payments to plans from a minimal increase of 2 percent up to 3 percent each year, raised the existing floor payment in rural counties, and created a separate and higher urban floor payment.
Beneficiaries’ Access and Choice of Plans
From 1997 to 2003, the widespread exit of MA plans reduced beneficiaries’ choices and weakened confidence in Part C. Moreover, with the exception of floor counties, the BBRA and the BIPA failed to reverse the declining participation in the plans and the enrollment of beneficiaries. By 2003, the number of what Medicare now called coordinated-care plan contracts (HMOs, PPOs, or POSs) had fallen 50 percent, to 151 from 309 in 1999 (Gold et al. 2004
), although some of the drop was attributable to the health plans’ mergers and acquisitions. There still were few other plan types offered besides HMOs, and there continued to be a wide geographic variation in plans’ availability across markets, with 40 percent of beneficiaries still lacking access to a Medicare managed care plan ().
Despite the increase in payments to those rural counties receiving the floor rates, beneficiaries in rural areas continued to have poor access to an MA plan. Whereas in 2001, 94 percent of beneficiaries living in a metropolitan statistical area (MSA) with at least one million people had an MA HMO in their county, only 5 percent of those living in counties not adjacent to a MSA had access to a plan. Furthermore, those plans that were available in rural areas offered less generous benefits than did those available in urban areas (MedPAC 2001
). This lack of entry was consistent with an observation we made earlier: that plans’ participation depends on being able to strike favorable bargains with suppliers, and the market power of the relatively small number of providers tilted the bargaining advantage toward the provider. In addition, the cost of marketing in sparsely populated areas was higher (MedPAC 2001
). The lack of favorable conditions in rural markets for HMOs, together with the more generous rural payment floors, opened the gates to the entry of PFFS plans in rural markets when the participating TM providers were required to accept reimbursement from PFFS plans at TM rates.
PFFS plans gave most rural beneficiaries an option other than TM, at least on paper, with the percentage of beneficiaries in rural areas having a choice rising from 21 percent in 2000 to 62 percent in 2003 (Gold et al. 2004
). As explained earlier, however, PFFS plans were completely different from the original TEFRA vision of a staff or group model HMO offering health insurance distinct from TM. Not only were the PFFS plans explicitly prohibited from any utilization management techniques, but they also did not have to report or satisfy any measures of quality. Their ability to pay at TM rates made moot the plans’ lack of bargaining power in highly concentrated rural markets. Beneficiaries in rural counties thus had a “choice” in name only. From their perspective, the PFFS plans placed no restrictions on the providers they could use or on the treatment choices of those providers (just like TM). But since the PFFS plans in the floor counties were being reimbursed at rates on average higher than TM, this effectively put money on the table that, through competition, meant better benefits for their beneficiaries than for those in TM. It took some time, however, for the market to exploit this opportunity and for Medicare to bear the resulting increase in spending.
Medicare Program Savings and Employer-Sponsored Health Insurance
Between 1997 and 2003 Medicare continued to lose money on those beneficiaries who enrolled in MA plans, partly because of the payment floors and partly because of favorable selection into Part C. Indeed, the continued favorable selection overwhelmed the ability of risk adjustment to pay less for less expensive beneficiaries. An analysis of the Medicare Current Beneficiary Survey found that in the early 2000s, MA enrollees were less likely than TM enrollees to report that they were in fair or poor health, that they had functional limitations, or that they had heart disease or chronic lung disease (Riley and Zarabozo 2006/2007
). But the analysis found no difference in reported rates of diabetes or cancer.
The evolution of Medicare and commercial insurance also continued to differ. On the private side, traditional indemnity insurance had all but disappeared in the private market, a stark contrast from Medicare (). Moreover, the BBA’s treatment of Part C suffered from bad timing by missing the halt in the health insurance market’s falling growth of health spending achieved by managed care in the private market in the mid-1990s.
By the end of the 1990s, managed care in the private sector had evolved from the plans first endorsed by the government through the HMO Act of 1973 and TEFRA, the vertically integrated staff and group model HMOs, to network plans with nonexclusive contracts with many independent providers. Providers’ and consumers’ resistance to restricted networks and utilization management had spawned a managed care “backlash” that pushed managed care plans to loosen their networks. Thus, whereas Medicare beneficiaries not in TM or PFFS essentially had only the choice of an HMO, private-sector employees could (and did) enroll in one of a broader set of managed care plans, particularly favoring the less restrictive PPO and POS plans (). Many larger employers offered their employees a choice of plans that varied in the restrictiveness of provider networks and in the degree to which care was managed. This likely made the shift from indemnity to managed care more palatable to the private sector and hastened the decline of open network fee-for-service plans in that market.
The managed care backlash also played out in the legislative arena, mostly through unsuccessful attempts in Congress and state legislatures to enact patients’ bills of rights and any-willing-provider laws that were meant to counter the managed care plans’ tactics of utilization management and network selective contracting, respectively. The judicial backlash saw efforts to hold plans liable for damages resulting from utilization management, and ultimately the Supreme Court upheld managed care practices (see Aetna Health, Inc. v. Davila, CIGNA HealthCare of Texas, Inc. v. Calad et al., 124 S. Ct. 2488, 2004). Physicians also brought a class action lawsuit against managed care plans for practices connected to capitation and risk contracting. Although some of the plans settled, those that fought the suit ultimately won on summary judgment (Re: Managed Care Litigation 2006a
The health plans’ selective contracting prompted providers in many markets to consolidate, thereby shifting market power toward providers and diminishing the plans’ negotiating ability. One example is the Brown and Toland Medical Group in San Francisco, which entered into a consent decree with the Federal Trade Commission (FTC). The FTC (2004)
alleged that Brown and Toland assembled otherwise competing physicians for the purposes of price fixing in contracting with managed care organizations (MCOs). Dranove, Simon, and White (2002)
found that managed care in a market area grew by an amount equivalent to that of a market with about ten equal-sized hospitals that changed into a market with six hospitals (Morrisey 2008
It was in this environment of decreasing plan participation and declining enrollment in MA plans that President George W. Bush’s administration and the Republican-led Congress looked to revitalize MA. The result was the passage of the Medicare Modernization and Improvement Act (MMA) in 2003, which—although perhaps best known for its creation of a prescription drug coverage benefit (Medicare Part D)—dramatically changed the MA program.