2.  Competitive Defined Benefit Proposal

Overview. The proposal would create a new "competitive defined benefit" program that, for the first time, would inject price and quality competition among health plans in Medicare. Unlike the current Medicare+Choice system, plans would be reimbursed for their full price of offering the defined set of Medicare benefit including a new subsidized drug benefit, and would compete over cost and quality. Such price competition would make it easier for beneficiaries to make informed choices about their health plan options. It also would provide incentives for beneficiaries to choose private plans offering high-quality health care while also saving them money by reducing their Part B premium costs. This saves the government money as well. Importantly, beneficiaries opting to stay in the traditional fee-for-service program would be able to do so without an increase in premiums.

a.  Beneficiary premiums based on choice of managed care plan

Policy: For the first time, the Medicare beneficiaries would have the ability to choose plans that can offer coverage with no or a lower premium than the traditional Part B premium. Right now, beneficiaries pay the same Part B premium regardless of the cost of their plan. Under the President's proposal, premiums would be lower if beneficiaries choose lower-cost managed care plans; the same if their plan's price is about equal to average traditional program costs; and more if their plan's price is higher than traditional Medicare costs. Beneficiaries opting to stay in traditional Medicare would pay their Part B premium as they do under current law; their premium would not be affected by this proposal. The system helps make beneficiaries more price sensitive, encouraging them to choose the highest quality, most efficient health plan option that suits their needs.

The amount that a beneficiary would pay in Part B premiums, assuming they opt for managed care, depends on the plan's price in relation to the traditional program costs (the Part D premium would also be included in this determination for participating beneficiaries). Those choosing a plan whose price is equal to 96 percent of traditional Medicare – the total payment that a plan will receive under current law in 2003 – would pay the same, current-law Part B premium (Part D also for enrollees who choose it). Those choosing a plan that is more expensive than this amount would pay the full additional cost of the plan; those choosing a less expensive plan could keep 75 percent of the savings. At this rate and given the current costs of Medicare, a beneficiary choosing a plan whose price is at or below about 80 percent of the average traditional Medicare's cost would pay no Part B premium. Beneficiaries would select plans during an open enrollment period each year, based on comparative information on premiums and quality.

Background/rationale: Under today's system, private plans use extra benefits to attract beneficiaries. Plans can afford to do so in certain parts of the country because historically, they have been overpaid according to major studies by the General Accounting Office (GAO), Mathematica and the Medicare Payment Advisory Commission (MedPAC). Given the shortcomings in the Medicare benefit package, it is understandable why beneficiaries would opt for this coverage. However, it is often difficult for beneficiaries to judge the value of various benefit packages and determine which one is best for them. This both limits effective and fair competition and probably results in beneficiaries getting less value in extra benefits because some of the extra benefits may be of little or no use to some beneficiaries. It also encourages risk selection. Plans hoping to attract healthy beneficiaries typically offer coverage targeted to such beneficiaries – offering, for example, health club memberships, and coverage for care when travelling outside the U.S. For this reason, advocates of competitive approaches agree that benefits must be comparable in order to have true competition on price and quality. Another concern about the current system is that, because plan payments are higher in some parts of the country, beneficiaries in certain areas have the option of extra benefits through managed care – in many cases, a free prescription drug benefit – while those in low-cost areas pay the same Part B premium and get few, if any, extra benefits if there are any plans available at all. The program subsidizes extra benefits in some parts of the country but not in others because of existing payment and program rules.

This proposal would allow managed care plans to compete for beneficiaries based on their price and quality in providing the defined set of Medicare benefits. This is possible because this proposal would also add the option of prescription drug coverage for all Medicare beneficiaries. Managed care plans would be explicitly subsidized for the prescription drug benefit. Moreover, the proposal puts money in the pockets of beneficiaries choosing low-cost plans, giving beneficiaries (rather than health plans) control over what extra benefits they are willing to buy and how they want to buy them. Plans would still have the option to offer extra benefits, but the premium for those benefits would not be subsidized by the government, reducing the inequities that occur today from area to area.

This competition could not work effectively without the new prescription drug option. Beneficiaries have a great need for this coverage, and it is part of almost all standard private insurance plans today. Beneficiaries have sought out managed care plans with drug coverage in areas where they are available. It would be unfair to replace benefits competition with price competition without putting in place an option to ensure that all beneficiaries have access to subsidized drug coverage, not just those in managed care. Equally as important, Medicare would explicitly pay managed care plans for drug coverage, lessening the uncertainty about whether plans can afford to do so in the future.

b.  Government payments based on plan prices

Policy: The government would pay Medicare managed care plans based on their prices, not a flat rate based on a statutory formula, as it does today. These Federal payments would be limited so that the government does not pay more than it does today (in general) but would be lower if beneficiaries choose lower-price plans. In other words, the government would save money when beneficiaries choose efficient plans – which does not happen in today's system. This should produce long-run efficiency and program savings if beneficiaries take advantage of the option to pay lower Part B premiums by enrolling in high-quality, cost-effective managed care plans.

Medicare payments to plans would be determined in two steps. First, private plans meeting Medicare eligibility criteria would bid on Medicare's defined set of benefits, including the new prescription drug and prevention benefits. Plans would have the option of including in this bid the cost of reducing or eliminating the cost sharing for Medicare benefits, so long as the value of that reduced cost sharing does not exceed 10 percent of the value of the defined Medicare benefits package. As is currently the case, the plans could further supplement the package by offering additional benefits for an additional supplemental premium, but these supplements would not count towards the price used to establish the government payment (note: the Secretary of Health and Human Services will examine the need and options for standardizing these supplemental benefits as part of her study on supplemental benefits in section II-3-d).

Second, this plan price would be compared to the cost of traditional Medicare for an average beneficiary. As under current law, maximum government payment for managed care plans would be set so that managed care enrollment of an average beneficiary would produce program savings. Specifically, the maximum government payment would be set so that the beneficiary pays the same Part B premium for a private plan with a price equal to 96 percent of traditional program costs. (Note: to the extent that savings from competition permit, this 4 percent current-law government savings from enrollment in a private plan could be reduced or eliminated). Instead of paying this flat amount for all plans, however, government payments would be based on the actual plan price when that price is below the maximum government payment level. As the plan price falls, the government payment also falls, by 25 percent of the reduction in price. Specifically, the government would pay the difference between the plan price and the beneficiary contribution (described above), up to a limit.

A different way to think about the government payment is as a percent of the total private plan price. For plans whose price is below about 80 percent of the average traditional program costs, the government would pay 100 percent of the price, and beneficiaries would pay nothing to enroll in those health plans. For plans whose price is between 80 and 96 percent of traditional Medicare costs, the dollar amount of the government payment increases, but it declines as a percent of the price as the beneficiary premium increases. The government payment would be capped for plans whose prices are above 96 percent of traditional program costs. Stated simply, the government payment increases with plan price increases up to a limit. That limit is the amount that the government pays for an average beneficiary in the traditional program less a 4 percent discount to account for the greater efficiency of managed care. This 4 percent discount is the same as that captured under current program rules.

Government payments to medical savings account (MSA) plans and private fee-for-service plans, two new options included in the BBA, would remain the same as under current law for the first few years of the new system.

Background/rationale: Unlike Medicare which pays managed care plans a flat payment based on their fee-for-service costs irrespective of plan prices, many private employers and other health care purchasers base their payments on plans' actual prices, and pay a larger share of the cost of lower-cost plans, to encourage price competition. The President's proposal would adopt this private employers' approach. All managed care plans would be paid their full price through a combination of government and beneficiary payments. The split between how much the beneficiary pays and how much the government pays would depend on the plan price relative to traditional Medicare program costs. The higher the price, the more beneficiaries pay since the government contribution rate declines relative to the price of the plan. This approach, paying plans a percent of their price up to a limit, is similar to that of the Federal Employees' Health Benefits Program.

Because payments would be based on the actual plan price, not a flat rate structure, Medicare would save not only when beneficiaries switch from the traditional program to managed care (due to the 4 percent discount for plans that cost the same as traditional Medicare) but also when they move from higher to lower cost managed care plans. This will produce savings over time. If savings from competition are sufficient, the government discount from the switch to managed care could be phased out.

c.  Risk and geographic adjustment

Policy: To ensure that competition is based on price and not risk selection, a strong risk adjustment system will need to be in place at the start of this proposal. Risk adjustment increases or decreases private plan payments based on the likelihood that a beneficiary will develop costly health problems. It lessens the incentive for private plans to search out healthy beneficiaries and avoid sick beneficiaries. The BBA directed HCFA to implement risk adjustment, which will be fully phased in by 2004. The government, not the beneficiary, makes the payment adjustment – so that all beneficiaries pay the same premium but the plan is fairly compensated. Because it is essential to have risk adjustment in a competitive payment system, this proposal would begin in 2003 when the new risk adjustment system is almost fully implemented.

To maintain a level playing field between the traditional program and private plans, government payments to private plans under this proposal would include an adjustment for geographic cost differences that affect plan operations and costs. This would put the premiums for managed care and the traditional program on the same, national basis (rather than have the private plan premium be local and the fee-for-service premium be national). Specifically, the government would adjust payments for plans in high-cost areas to reflect the full local costs, which is more than under the BBA formula. The increases in government payments in low-cost areas included in the BBA would be maintained in the President's plan. In other words, the higher payments to rural managed care plans secured in the BBA would be maintained to encourage plan participation in underserved rural areas. This two-part geographic adjustment system would be studied in its first several years by the Secretary of Health and Human Services to assure that it produces the intended effect.

Background/rationale: One of the most important changes to managed care payments in the BBA was the required implementation of risk adjustment. Medicare covers many high-cost elderly and disabled beneficiaries who could benefit from coordination of care that managed care offers. The failure to adjust for these potential costs (beyond the current demographic factors such as age) creates incentives for plans to sign up only healthy beneficiaries. More than half of all Medicare fee-for-service beneficiaries cost less than $500 per year, while less than 5 percent of beneficiaries cost more than $25,000 per year. Some of these differences are predictable and should be taken into account in setting government payments fairly. Risk adjustment also helps eliminate overpayments that are built into the system due to disproportionate enrollment of healthy beneficiaries, according to the General Accounting Office. For these reasons, virtually all experts, including the MedPAC, support implementation of risk adjustment. The President's plan maintains the current phase-in schedule for risk adjustment that was announced in March.

Similarly, geographic adjustment of government payments helps protect beneficiaries and promote competition. The current Medicare Part B premium is set nationwide – all beneficiaries pay the same premium regardless of where they live. In contrast, government payments to private plans in different areas are adjusted by a complex formula involving "blended" national and local costs, historical costs, and statutory limits. Compared to payments based on local costs only, the blend included in the BBA increases private plan payments in low-cost rural areas, but reduces payments to private plans in high-cost areas. Under the proposed system, beneficiary premiums for managed care would no longer be fixed, but would vary based on plan prices. Since plan prices will implicitly include the local costs of care, if the government does not pay for these local costs, then the plan would pass through these costs to the beneficiaries in the form of higher premiums. This would make the beneficiary premium for managed care in high-cost areas much higher than that of the traditional program, discouraging enrollment. The full geographic adjustment of the government payments in high-cost areas included in this proposal is critical to making the competition between the traditional program and managed care premiums equitable. It is likely, however, that costs in these areas would fall as competition reduces unnecessary utilization. The proposal would also keep the current partial geographic adjustment system for low-cost areas, maintaining the provisions included in the BBA to encourage private plans to enter rural areas.