Former Obama administration budget director Peter Orszag has been a staunch opponent of “overpayments” in the Medicare Advantage program, which allows seniors to select from a menu of private insurance options, for years. In selling ObamaCare, the Obama administration made the case that the program paid too much to private providers and that payments could be reduced without affecting benefits.

Orszag was one of the chief proponents of this argument: In 2009, he told an audience of health industry insiders, "I believe in competition. I don't believe in paying $1.30 to get a dollar.” And he helped translate that belief into a legislative plan: Under Orszag’s watch, the Obama administration signed a health care overhaul that relies quite heavily on savings generated by cuts to allegedly excessive Medicare Advantage (MA). More than 30 percent of the law’s $716 billion in Medicare payment reductions were set to come from the MA program.

In a Bloomberg View op-ed today, Orszag continues to argue in favor of those payment reductions. He might want to have a chat about this with his former employers at the White House. The administration has delayed its plan to reduce overpayments until at least 2014 in order to run a “pilot program." The Department of Health and Human Services says this demonstration project will help test ObamaCare's revised payment scheme, which was supposed to tie payments to quality. The way HHS plans to do that is by continuing with the old, “excessive” payment rates for a large number of providers nationwide that do not meet the law’s quality standards. At a cost of $8 billion, it’s by far the largest pilot program of this type ever conceived — indeed it is larger than all other Medicare demonstration projects since 1995 combine — so one hopes it will provide some useful information.

It’s difficult, however, to see how the experiment will provide reliable results. And anyone wondering how exactly this will help HHS determine whether or not its MA quality payments work, you’re not alone: The Government Accountability Office recently looked at the HHS plan and concluded that “the design of the demonstration precludes a credible evaluation of its effectiveness in achieving (the administration’s) stated research goal.” The GAO report also issued a strong recommendation that the HHS demonstration program be shut down, and the overpayments be cut as planned.

Orszag also warns that Medicare Advantage relies on a system of payment tweaks known as risk adjustment to counteract overpayments. But, he writes, although risk adjustment mechanisms have improved in recent years, “evidence suggests it still does not work very well.” And he points to 2011 research for the National Bureau of Economic by four economists who look at MA’s risk adjustment program and warn of its limits.

I’m glad to see that Orszag is familiar with this research, because it suggests some potential problems with ObamaCare, which relies on a similar sort of risk adjustment within its health exchanges. A 2010 working paper on risk adjustment by the same authors not only found that risk adjustment did not work particularly well, but warned that ““in light of the results presented here, one question is how well a risk adjustment mechanism will reduce adverse selection in the exchanges” created by President Obama’s health law.

Despite GAO’s recommendation, HHS has yet to cancel the MA bonus payment, which if nothing else provides a solid data point in favor of the argument that political pressure will make it hard to restrain Medicare spending through technocratic payment tweaks to providers. All in all, I think Orszag has (perhaps unintentionally) identified some real flaws in ObamaCare’s design, and a number of potential implementation hazards.

A further wrinkle comes from recent research suggesting that even though MA pays more, the program’s competitive private design may have actually succeeded, at least partially.


A paper in the Journal of the American Medical Association (JAMA) by three Harvard economists reports that although MA payments are higher on a dollar for dollar basis, the program is actually cheaper than traditional fee-for-service Medicare when measured on a cost-per-benefit basis, providing the same set of services for about 9 percent less. One potential reason why? Competition amongst private plans. Reihan Salam has a tasty, cheeseburger-based analogy that helps explain how this works:

Imagine that there is a federal program devoted to providing seniors with cheeseburgers. There is a publicly-run cheeseburger assembly plant that needs $15 to produce a quarter-pound burger with a toasted bun, a sliced tomato, and cheddar cheese. Costs have been rising over the years as the price of the discrete components of this standard cheeseburger have been rising, for a variety of complex, interrelated reasons. In recent years, the federal cheeseburger program has allowed cheeseburger beneficiaries to choose private cheeseburgers at public expense. Various private cheeseburger firms bid for the right to take part in this bonanza of subsidies, and on an enrollment-weighted basis they bid $14 — a bid that reflects what they need to produce that same quarter-pound burger with a toasted bun, a sliced tomato, and cheddar cheese plus enough to turn a profit.

But rather than pay these private cheeseburger firms $14, the amount of the bid, the federal cheeseburger program has devised a complicated benchmark based on what it costs the publicly-run cheeseburger assembly plant to produce said cheeseburger. The end result is that private cheeseburger firms are in many cases paid $16 to take part in the program. This doesn’t mean they pocket an extra $2 in profit, however. These private cheeseburger firms could be required to offer more or higher-quality ingredients — grass-feed beef, romaine lettuce, muenster cheese, fried onions, and so forth. So it is true that these private cheeseburgers cost the system more than the public cheeseburgers. But this reflects the benchmark and, in some cases, the fact that we’re not making an apples-to-apples comparison.

As the authors of the JAMA paper note, this has significant implications for premium support Medicare plan proposed by Reps. Paul Ryan and Sen. Ron Wyden, which relies on a similar form of competition to restrain Medicare spending. And it suggests that in the quest to reform Medicare we ought to be looking for ways to harness private competition to provide benefits more cheaply rather than focus on technocratic adjustments to the payment system, especially in light of the long and deeply mixed record of attempts to control federal health spending through pricing tweaks.