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Sharing Costs Is No Way to Fix Medicare

Author: Peter R. Orszag, Adjunct Senior Fellow
May 24, 2011
Bloomberg.com

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Many Republican policy makers appear conflicted about the budget plan put forward by the House Budget Committee chairman, Representative Paul Ryan of Wisconsin. They are torn because they like its substance, but believe it is bad politics, especially among elderly voters. In truth, the substance is not particularly appealing either.

At the heart of the Ryan plan is a shift within Medicare toward consumer-directed health care ó which in turn is predicated on increasing beneficiaries' "skin in the game" to make the health system more efficient.

While more consumer cost-sharing would help reduce unnecessary care, the plan would not live up to its billing in cutting health costs for America. According to the nonpartisan Congressional Budget Office, it would do the opposite. That's right: The CBO found that the Ryan Medicare proposal would substantially increase total health-care spending.

Before delving into the Ryan plan in more detail, let's take a quick detour into why consumer-directed health-care reform ó though useful to some degree ó may not be the panacea it's often held out to be. The core problem is that health-care costs are concentrated among expensive treatments for chronic diseases and end-of-life care ó and even consumer-directed approaches retain deep third-party insurance against such cases (which is, after all, the whole point of insurance). Consider that, if you rank Medicare beneficiaries by cost, one-quarter of patients account for more than 85 percent of total costs. So even if the other 75 percent spend less on doctors and medicine, they can't take a significant bite out of the total.

Experiments With Cost-Sharing

Perhaps the most famous research on consumer cost-sharing is the RAND Health Insurance Experiment, which was conducted with 2,750 families from 1971 to 1982. Each family was randomly assigned to one of five formulas determining how much of their medical expenses they would pay themselves.

The RAND results showed that the introduction of cost- sharing can reduce medical spending without causing harm to health ó that holy grail of health policy. The biggest reductions in the RAND study, though, came in moving from zero expense for families to at least some cost-sharing. As we already have some cost-sharing in our current system (co-pays and deductibles), that finding doesn't suggest a new path to savings. And, unfortunately, the results from raising cost- sharing above current levels were generally more modest.

Cutting Back on Medicine

Other evidence, from studies of employers that have adopted consumer-directed approaches in the form of high-deductible health plans such as health savings accounts, is similarly mixed. Significant cost reductions typically occur in the first year, perhaps because of pent-up demand for health services, but these are often partially if not fully reversed in the second and third years. And some of this research has highlighted a longer-term concern: To save money in the short run, people tend to cut back on crucial medicines. This could lead to higher medical costs over time.

Which brings us back to the Ryan plan. Under that proposal, starting in 2022, the government would issue new Medicare beneficiaries a payment that they could use to purchase private insurance. These payments would increase in line with the consumer price index but not with faster-rising health costs. The slower increase in payments would generate large savings (and less risk) for the federal government; indeed, this would be the single most important driver of savings from the Ryan budget plan as a whole.

Beneficiaries Pay More

As the government paid relatively less for Medicare, beneficiaries would bear an increasing share of the cost of their care. It is no great accomplishment, however, merely to shift health expenditures from the federal government to consumers, without doing anything to decrease them in total.

The CBO's analysis of the Ryan plan confirms that federal expenditures would be reduced, by a lot. By 2030, payments for a typical beneficiary would be more than 20 percent lower than current projections, according to the report, and the beneficiary's personal costs would increase.

So far, nothing unexpected. On the critical metric of whether the Ryan plan would reduce total health-care costs, though, the CBO conclusion is shocking: The plan would not only fail to decrease health-care costs per beneficiary, it would increase them Ė- by an astonishingly large amount that grows over time. By 2030, health spending on the typical beneficiary would be more than 40 percent higher under the Ryan plan than under existing Medicare, according to the CBO report.

Health-care costs would not be reduced on the backs of seniors; they would be raised on the backs of seniors.

Cost-Containment Machine

How could this possibly be, when the point of reform is to reduce costs? The CBO points to two factors: Private plans have higher administrative costs than the federal Medicare program, and less negotiating leverage with providers.

Everything in life is relative. The CBO's analysis of the health-reform act that was passed last year was, well, lukewarm on its potential to reduce costs. Compared with the Ryan plan, though, the health reform act comes across as an efficient cost- containment machine. The truth is that constraining future health care costs will require a variety of approaches, but in particular it will mean improving the information that providers have about their patients and best practices, and the incentives that providers are given to deliver better care, especially in expensive cases. To lean exclusively or even primarily on shifting costs to consumers would be a mistake.

So here's the message to those vacillating Republican policy makers: There's no need to feel guilty about backing away from the Ryan plan for reasons of political expediency. If your goal is to reduce health spending significantly, you can safely retreat from it on its substance.

This article appears in full on CFR.org by permission of its original publisher. It was originally available here.

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