The Medicare Monster

A Cautionary Tale

Steven Hayward & Erik Peterson from the January 1993 issue

(Page 4 of 5)

The Hospital Insurance Fund trustees have had a prickly reaction to King’s observations. In last year’s annual report, the trustees offered this grumpy dismissal: "We believe that the comments on real-wage gains by the HCFA Chief Actuary also represent an expression of a preference outside the bounds of the legally required actuarial opinion." In an appendix of the latest annual report, the trustees take aim at King again, but without offering any substantive refutation of his arguments: "It is perplexing and disconcerting that an actuarial opinion with unjustifiable qualifications has been allowed to be repeated for several years in the HI reports." In other words, shut up.

Nobody in Congress is paying much attention to this looming fiscal catastrophe. An HCFA official told REASON, "People keep thinking that if we just push back little by little the date of the trust fund’s insolvency, we’ll be all right." Congressional liberals thought it would make a big difference to more than double the taxable wage base–from $51,300 to $125,000–as a part of the 1990 budget deal with President Bush, but, as the HCFA official told us, "Some politicians were surprised to find that this will only push back the date of the trust fund’s bankruptcy by about two years."

The other half of the Medicare program, Part B Supplemental Medical Insurance, is a similar tale of unexpected soaring costs. Its funding was, in theory, established on a more stable base than the hospital-insurance program. The supplemental program was to draw 50 percent of its revenue from insurance premiums paid by beneficiaries and 50 percent from federal matching funds from the general treasury. As program costs grew, however, adjustments were to be made in the monthly insurance premiums (which started out at $3.00 a month in 1966; today’s Medicare part B premium is $31.80 per month) to keep the 50-50 ratio.

This plan ran into trouble by the insurance suggests early 1970s, again because the cost of medical care rose faster than income. Elderly enrollees, many of whom lived on fixed incomes, were paying an increasing share of their income for supplemental-insurance premiums. In the 1972 amendments, Congress stipulated that these premiums could rise no faster than Social Security benefits, regardless of program costs. Since 1972, the supplemental program has required ever larger subsidies from the general fund. The result: The Treasury now coughs up $3 for every $1 paid in premiums. In typical Orwellian doublespeak, Congress continues to describe the program as "self-supporting."

It seems never to have occurred to anyone during the debates about Medicare that increasing the demand for health services would generate huge pressures on hospital costs. The planners seem to have overlooked the fact that if you shift the demand curve sharply outward without moving the supply curve, prices will go up. The original 1965 cost projections allowed for a 10-percent increase in hospital-admission rates among the elderly, but in fact hospital-admission rates among the Medicare-eligible rose immediately by 25 percent, the rates for surgical procedure by 40 percent, and the number of hospital days by 50 percent.

The federal government has approached the problem of cost containment gingerly, not wanting in the early years to jeopardize the political support for Medicare within the health-care industry with stringent reimbursement policies or among the elderly by restricting benefits. But with the cost of the Medicare program growing at more than 15 percent a year (in 1975 Medicare outlays jumped a whopping 30 percent), reality has forced the government to try to impose cost containment. The parade of imaginary horrors the AMA predicted in 1965–such as price fixing for specific procedures and limits on doctors’ fees–is finally coming to pass.

The results of cost containment, like the history of the fiscal projections for Medicare, have generally been disappointing and provide another sobering precedent for designers of universal national health insurance. In the 1970s, the federal government adopted the "Certificate of Need" program, which required states to review and approve capital investments of health-care providers. While correctly recognizing that Medicare and other government health programs provided perverse incentives for hospitals to increase their overhead by buying new capital equipment, the Certificate of Need program was a crude attempt at government rationing. Even the Congressional Budget Office, in a recent report, concludes that the program turned the capital equipment procurement process into a political process, dependent more on influence and political clout rather than on actual medical need.

A more serious strategy was adopted by the Reagan administration in the mid-1980s: the Prospective Payment System, which reimburses hospitals according to a fixed-price structure based on Diagnostic Related Groups. For example, if the average gall-bladder surgery costs $10,000 and requires four days of hospitalization, that is what the government will pay the hospital for a Medicare patient, regardless of how long that particular patient may need to stay. During the aggressive implementation of this policy in the mid-1980s, the cost of Medicare’s hospital-insurance program grew at single-digit rates for the first and only time in its history.

The attempt to contain costs of Medicare’s supplemental insurance program by freezing physician fees from 1984 to 1986 was less successful. That program cost continued to rise by more than 10 percent a year. A Congressional Budget Office review of the fee freeze and other attempts to fix prices notes that doctors adapt simply by increasing volume. A 1991 CBO study concludes: ":Studies of the effects of fee freezes or controls on physicians’ prices indicate that they result in a pronounced volume offset." The same inherent weakness diminishes the long-term prospects that the PPS/DRG system can reduce the rate of health-care cost inflation.

Hospitals have adapted to the system by qualifying patients for more tests and procedures, by shifting patients to different DRG designations that carry a higher reimbursement rate, and especially by shifting patients from hospital to outpatient settings, which shifts the cost to the supplemental-insurance program. An HCFA official told us: ‘There is simply no way to contain costs, and nothing on the horizon to contain costs."

The lesson of both PPS and the physician-fee cap is that government efforts to control health costs through price fixing are like trying to press the bumps out of a tube of toothpaste. Press in one area, and the tube bulges in another. To smooth out all the bumps by force, you have to apply pressure to all areas of the tube. The cost-containment logic of fixing prices for government health programs is leading inexorably to government price fixing for the entire health-care system. It is already happening in two ways.

First, private health insurers, wary of having costs shifted onto them, are adopting the Medicare PPS rates as their own reimbursement policy. "Over time," says Anthony Masso, director of managed care for the Health Insurance Association of America, "you will probably see [the Medicare reimbursement rates] being used by almost all private-sector insurance carriers."

Second, the latest attempt at Medicare cost containment is an even more ambitious price-fixing scheme that not only restricts the amount the government will pay for hospital procedures but even sets fees individual practitioners should receive in hospital and clinical settings. In the best socialist style of centralized decision making and price fixing, HCFA has commissioned a multimillion-dollar study to develop a ranking of the "relative value" of medical procedures on which to base the new reimbursement rates.

Having learned from the failure of the fee freeze in the mid-1980s, the government is attempting to head off the possibility of increased volume by reducing physician-reimbursement rates by as much as 30 percent in some cases. But instead of increasing volume, this time doctors and clinics are cutting back on their Medicare practices. A 1990 survey by the Association of American Physicians and Surgeons found that nearly 50 percent of physicians would respond to a cut in Medicare fees by seeing fewer Medicare patients.

"Private doctors," said Dr. Jane Orient, a past president of AAPS, "if they remain in business at all, will probably be cutting back on their Medicare practice, or dropping it altogether."

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