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Private Plans Won’t Save Medicare Money

Writing in the Weekly Standard, James Capretta and Yuval Levin contend that a recent Journal of the American Medical Association (JAMA) article shows that private plans cost less than traditional Medicare.  Washington Post columnist Robert Samuelson recently cited the same study.  But Peter Orszag, former director of both the Office of Management and Budget and the Congressional Budget Office, explains in a recent Bloomberg column why these writers drew the wrong conclusions.

Medicare offers beneficiaries the choice of receiving their benefits through traditional Medicare or through private insurance plans, known as Medicare Advantage plans.  The JAMA article, by Harvard’s Zirui Song, David Cutler, and Michael Chernew, examines the bids that Medicare Advantage plans make to participate in the program.  These bids represent the amount that a private plan is willing to be paid to cover a typical Medicare beneficiary.

Orszag writes:

In 2012, Medicare Advantage bids have come in on average a bit below traditional Medicare costs, analysis by the Medicare Payment Advisory Committee shows. Even more relevant to the revised Ryan plan is that, in 2009, the second-lowest bid in each U.S. county — which is what the new plan would be based on — was an average of 9 percent below traditional Medicare, a new analysis in the Journal of the American Medical Association shows.

Does this mean that Medicare Advantage plans cost less than traditional Medicare?  “No,” says Orszag, “because there’s a very good reason to believe that the 9 percent differential is a mirage.”  Why?  Because Medicare Advantage plans tend to enroll beneficiaries who are relatively healthy, and Medicare’s risk-adjustment process is highly imperfect.

Plans that can better predict beneficiary costs [are able] to game the system by selecting beneficiaries who are able to cost less than their risk-adjusted payments. ... How big is this selection effect in Medicare Advantage? The evidence suggests it’s huge. The most careful analysis was reported in a 2011 National Bureau of Economic Research paper . ...  In 2006, ... relative to their bids, the plans were overpaid by $2,000 per beneficiary — or roughly 25 percent of the bid, on average.

That overpayment rate, furthermore, is likely to be higher for the second-lowest bid in each county, and it is therefore likely to be larger than the much-touted 9 percent discount, which doesn’t appropriately account for the selection effects.

The bottom line is that, if anything, Medicare Advantage bids are above, not below, traditional Medicare — once you do the analysis correctly, on an apples-to-apples basis.

The question of how the costs of private health plans compare to that of traditional Medicare is a timely one.  House Budget Committee Chairman Paul Ryan has proposed to gradually replace Medicare with a system of vouchers that seniors could use to help buy private health insurance or — in this year’s version of his proposal — a form of traditional Medicare.

We reported that the 2011 version of his proposal would have raised total health care spending and massively shifted costs to beneficiaries.  Ryan has not provided enough detail about the 2012 version of his plan for CBO to prepare a precise estimate, but the new plan is enough like the old one that it would have the same kinds of impacts, even though the numbers would differ.