Privatizing Medicare


have publicly supported the privatization of Medicare since they
took control of Congress in 1995. Democrats have supported adding
drug coverage to Medicare since 1999. In 2003, Republicans linked
the issues.  

Bush announced last January that he would support adding a scrawny
drug benefit to Medicare on the condition that Medicare beneficiaries
be given financial inducements to join HMOs, and on June 12 House
Republican leaders introduced a bill that adds scrawny drug coverage
to Medicare and puts great financial pressure on seniors to join
HMOs beginning in 2010. On June 27, the House passed the Republican
bill by a single vote. The bill must now be reconciled with a similar
Senate bill that also passed on June 27, which puts considerably
less pressure on seniors to enroll in HMOs. 

media has given the drug coverage portion of this story extensive
coverage and has done a good job of reporting on Bush’s campaign
to hold drug coverage hostage to his privatization plans. But the
media has devoted very little ink to explaining how privatization
would work under the Bush and House proposals. Worst of all, the
mainstream media has made no effort to represent the views of experts
who believe HMOs cannot possibly save Medicare money and might damage
the quality of care. 


New York Times

coverage represents the best
and the worst of the media’s coverage of the drug and privatization
issues. Last January, the


was the first news outlet
to report that Bush intended to give the two issues high priority
in 2003. The article, which ran on January 3, made it clear that
Bush was seriously considering making seniors leave the traditional
Medi- care program (where 89 percent get their coverage now) and
enroll in an HMO (where the other 11 percent are covered), and that
some Democrats were opposed to such a plan. The article quoted the
chief of staff of Rep. Pete Stark (D-CA) saying, “If the price
of a prescription drug benefit is the end of Medicare as we know
it, that’s not a price worth paying.”  

the lengthy article gave no indication that a substantial body of
research demonstrates that the HMOs that are now insuring seniors
add to rather than lower Medicare’s costs. In fact, the article
created the impression that HMOs were lowering costs by describing
HMOs as “more efficient [and] less costly” than traditional
Medicare, and by presenting the HMO industry’s claim that Medicare
doesn’t pay HMOs enough. 

factors make it impossible for HMOs to insure the elderly for less
money than the traditional Medicare program does: HMOs have overhead
costs that providers (doctors and hospitals) serving traditional
Medicare patients do not incur and that Medicare therefore does
not pay for; and HMOs pay providers more than traditional Medicare

overhead expenditures, that is, their payments for things other
than medical care, equal about 20 percent of total HMO revenues.
The main categories of HMO overhead expenditures are marketing,
policing doctors, lobbying, obscene salaries and perks for management,
and profit for insurance company shareholders. Under the traditional
Medicare program, Medicare pays providers directly; there is no
HMO middleperson and, therefore, no HMO overhead to siphon off 20
percent of Medicare’s payments before it reaches providers.
But under the HMO portion of the Medicare program, Medicare pays
the HMO middlepeople and HMOs, in turn, pay providers, but only
after the HMOs have scraped off 20 percent of their payments from
Medicare to cover their overhead. 

evidence that HMOs have overhead costs in the range of 20 percent
of revenues comes from Wall Street. On Wall Street, HMOs brag about
their “medical loss” ratios—the ratio of their medical
expenditures (their payments to providers) to their total revenues.
An HMO loss-to-revenue ratio of 70 percent is considered great for
investors whereas a ratio of 90 percent is considered abysmal. No
one has calculated the average medical loss ratio for the entire
US health insurance industry, but it’s possible to do so for
the largest insurers. In 1999, the medical expenditures of today’s
four largest health insurance companies (United Health- Care, Aetna,
Cigna, and Wellpoint) averaged about 80 percent of the revenues
of these companies.  

existence of HMO overhead means that HMOs have to reduce their medical
costs by more than 20 percent in order to save Medicare money. That’s
an enormous handicap. But huge overhead is not the only HMO handicap.
HMOs also pay higher rates to providers than traditional Medicare
does. The

New York Times

was apparently the only major news
outlet to report this fact. Paul Ginsburg, president of the Center
for Studying Health System Change, recently told the


“In most areas of the country, payment rates for hospitals
and physicians that are negotiated by private plans are higher than
those paid by the [traditional] Medicare …program.” According
to the Medicare Payment Advisory Commission, which advises Congress,
hospitals charge HMOs about 40 percent more than they charge Medicare
and physicians charge HMOs about 15 percent more. Together, these
differences in provider rates add another 20 percent to HMO costs. 

ability to pay lower fees is due to its size. With 36 million people,
traditional Medicare is far and away the nation’s largest insurance
program. It’s so big and provides such a large portion of the
average provider’s revenues that providers can’t afford
to walk away from the Medicare population. 

we add HMOs’ higher overhead (20 percent) to their fee disadvantage
(20 percent), we’re looking at a handicap equal to roughly
40 percent. HMOs have only two ways to offset this enormous handicap:
(1) they can deny much more medical care to their patients than
traditional Medicare denies its patients; (2) they can seek to avoid
the sickest patients and enroll only the healthy. Neither strategy
is morally or politically acceptable. 

HMO industry’s efforts to ration health care in the nonelderly
market backfired so badly in the mid-1990s that the industry has
begun to back away from its most aggressive managed-care tactics.
If the nation wouldn’t tolerate aggressive rationing by HMOs
among the nonelderly, it would certainly not tolerate even more
aggressive rationing among the elderly. 

leaves the HMOs with only one strategy: to enroll only the healthiest
seniors—a tactic called cherry picking—but get paid as
if they were enrolling average seniors. At least two dozen studies
have demonstrated that HMOs have benefited from this strategy for
at least the last two decades. Congress has been apprised repeatedly
of this fact. The U.S. General Accounting Office (GAO), the Congressional
Budget Office, and the Medicare Payment Advisory Commission have
all sent reports to Congress stating that Medicare is overpaying
Medicare HMOs by large amounts because the HMOs attract disproportionately
healthy seniors. The GAO reported in 1999, for example, “studies
conducted by us, …the Medicare Payment Advisory Commission…and
others demonstrated that the Medicare program spent more on beneficiaries
enrolled in health plans than it would have if the same individuals
had been in  [traditional Medicare]. This unexpected result
occurred because Medicare  payments were based on the estimated
cost of… beneficiaries [in traditional Medi- care] in average
health and were not adequately adjusted to reflect the fact that
plans tended to enroll beneficiaries with better- than- average

studies the GAO cited indicate the Medicare overpayment to HMOs
lies somewhere in the range of 15 to 45 percent. If this seems hard
to believe, consider just one of the studies the GAO was referring
to—a study by the Physician Payment Review Commission, a predecessor
to the Medicare Payment Advisory Commission. In its 1996 report
to Congress, this commission reported a study it had done which
found that the seniors who enrolled in Medicare HMOs were so healthy
they cost the HMOs only 60 percent of the average cost of Medicare

we tack on another type of overpayment—this one equal to about
5 percent of Medicare payments to HMOs—caused by HMOs fraudulently
inflating their administrative costs, a problem documented by a
1998 report of the Department of Health and Human Services, we may
say Medicare has been overpaying the average HMO by somewhere in
the range of 20 to 50 percent. It is this gigantic, unintended overpayment
that makes it possible for some HMOs to survive in the Medicare
“market” despite big handicaps—high overhead and
relatively high provider payments. 

HMOs may continue forever to get away with inflating their administrative
costs and inducing Medicare to pay it (the Clinton administration
showed, and the Bush administration has so far shown, no interest
in preventing HMOs from padding their Medicare charges), but they
can’t continue forever to cherry pick. Enrolling the healthiest
of the Medi- care population is possible only as long as the HMOs
enroll a tiny proportion of that population. If and when HMOs begin
to enroll a growing proportion of the Medicare population, which
is the Republicans’ goal, HMOs will find it more and more difficult
to avoid their share of the sick. As the HMO industry’s share
of Medicare beneficiaries rises from its current level of 11 percent,
and as the typical HMO enrollee becomes more typical of the Medicare
population, the unintended cherry-picking subsidy to the HMOs will

start out with two financial disadvantages against traditional Medicare:
(1) they generate administrative costs equal to roughly 20 percent
of their revenues; (2) they pay higher provider fees equal to about
another 20 percent. It’s conceivable that a pro-HMO Congress
could eliminate the latter handicap by simply ordering providers
to charge Medicare HMOs no more than they charge the traditional
Medical program. But even if Congress would do that over the objections
of the physicians, hospitals, and (if drug coverage is added to
Medicare) the drug companies, the HMO overhead problem would still
remain. The HMOs’ two remaining weapons—rationing and
cherry picking—will be nowhere near potent enough to offset
their overheads. Aggressive rationing of Medicare beneficiaries
by HMOs is not politically and morally acceptable, and the HMO cherry-picking
advantage will disappear as privatization gradually brings a larger
and larger portion of the Medicare population into HMOs. 

cannot save Medicare money. Republicans should drop their privatization
proposal and kick the HMOs out of Medi- care all together.

Kip Sullivan
lives in Minneapolis. He writes frequently about health policy.