Statement of
Peter R. Orszag
Director

The Medicare Advantage Program:
Trends and Options

before the
Subcommittee on Health
Committee on Ways and Means
U.S. House of Representatives

March 21, 2007

Mr. Chairman, Congressman Camp, and Members of the Subcommittee, I am pleased to appear before you today to discuss the Medicare Advantage program. My testimony focuses on several themes:

• Unexpectedly strong growth in enrollment in the Medicare Advantage (MA) program during 2006 and the beginning of 2007 led the Congressional Budget Office (CBO) to increase its projections for both enrollment in and spending on the program.
  
  
• Medicare's payments for beneficiaries enrolled in Medicare Advantage plans are higher, on average, than what the program would spend if those beneficiaries were in the traditional fee-for-service (FFS) sector. As a result, shifts in enrollment out of the FFS program and into private plans increase net Medicare spending. Policymakers need to weigh that additional cost against any differential benefits provided by Medicare Advantage plans.
  
  
• The rate of growth in enrollment and the cost differential with the traditional fee-for-service sector are particularly large in private fee-for-service (PFFS) plans, whose enrollment is concentrated largely in rural and some suburban areas.
  
  
• Reducing the payment differential between Medicare Advantage and the fee-for-service program would result in potentially substantial savings to the Medicare program but also in a reduction in the supplemental benefits and cash rebates that plans can offer to enrollees and reduced enrollment in Medicare Advantage plans.

The central long-term fiscal challenge facing the nation involves health care costs. Policymakers face both challenges and opportunities in addressing those costs. Over long periods of time, cost growth per beneficiary in Medicare and Medicaid has tended to track cost trends in private-sector health markets. Many analysts therefore believe that significantly constraining the growth of costs for Medicare and Medicaid is likely to occur only in conjunction with slowing cost growth in the health sector as a whole. A variety of evidence suggests opportunities to constrain health care costs without adverse consequences. So a basic challenge will be to restrain cost growth without harming incentives for innovation or Americans' health (and perhaps even improving it). Moving the nation toward that possibility--which will inevitably be an iterative process in which policy steps are tried, evaluated, and perhaps reconsidered--is essential to putting the country on a sounder long-term fiscal path. Changes to the Medicare program should be evaluated with that broader perspective in mind.

Background on Medicare Health Plans

Medicare provides federal health insurance for 42 million people who are aged or disabled or who have end-stage renal disease. Part A of Medicare (Hospital Insurance) covers inpatient services provided by hospitals as well as skilled nursing and hospice care. Part B of Medicare (Supplementary Medical Insurance) covers services provided by physicians and other practitioners, hospitals' outpatient departments, and suppliers of medical equipment. Home health care may be covered by either Part A or Part B. The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (MMA) added a voluntary prescription drug benefit beginning in 2006 under Part D.

The majority of Medicare beneficiaries receive services through the traditional fee-for-service part of the program, which compensates providers using a set fee for each service. In nearly all areas of the country, however, Medicare beneficiaries have the option of enrolling in Medicare Advantage--the program through which private plans participate in Medicare--rather than receiving their care through the FFS program.⁽¹⁾ As of January 2007, about 19 percent of beneficiaries were enrolled in private health plans, which accept the responsibility and financial risk for providing Medicare benefits.⁽²⁾ Although the payment system for private plans has been modified several times during the more than 20 years that they have participated in Medicare, a key feature of the system has remained intact: Plans that offer Medicare benefits for less than the amount of their payment from the government are required to give enrollees additional benefits or, in an option that became available recently, rebates on their Part B or Part D premiums.⁽³⁾ Those additional benefits and rebates of premiums are a major incentive for beneficiaries to enroll in Medicare Advantage plans and may be particularly attractive to people with relatively low income.⁽⁴⁾

About 75 percent of the Medicare beneficiaries enrolled in private plans are in health maintenance organizations (HMOs) or local preferred provider organizations (PPOs). The other main types of available plans are regional PPOs and private fee-for-service plans. Both HMOs and PPOs have comprehensive networks of providers, but PPOs allow beneficiaries to obtain care outside the network if they pay a higher amount. Some HMOs offer coverage for services received outside their network (and thus resemble PPOs), while others require that their enrollees receive all of their nonemergency care within the network. Regional PPOs, an option that became available in 2006, are required to serve broad regions of the country rather than defining their service areas on a county-by-county basis. A key feature of many HMO and PPO plans under Medicare Advantage is wellness programs and case management services; those services are intended to promote better coordination and more effective use of health care. PFFS plans allow their enrollees to obtain care from any provider who will furnish it and are not required to maintain networks of providers. Providers must decide at the time of service whether to accept a PFFS plan's terms of participation and thus agree to its payment rates, usually those of FFS Medicare.

In 2007, 82 percent of beneficiaries live in a county served by an HMO or a local PPO, up from 67 percent in 2005.⁽⁵⁾ Nearly all beneficiaries who do not have access to a local HMO or PPO have access to a regional PPO (and 99 percent have access to one of the three). All beneficiaries have access to a PFFS plan in 2007, up from 80 percent in 2006 and only 45 percent in 2005.

The Payment System for Private Health Plans

The latest changes to the payment system for private health plans were enacted in 2003 in the Medicare Modernization Act. The modified payment system is analogous to the previous system, and the incentives facing plans and beneficiaries are similar.

Beginning in 2006, private plans wanting to participate in Medicare must submit bids indicating the per capita payment for which they are willing to provide Medicare's Part A and Part B benefits.⁽⁶⁾ The government compares those bids with county-level benchmarks that are determined in advance through statutory rules. The benchmarks are the maximum payments that the government will make for enrollees in private plans.^(7),(8)

Under current law, benchmarks are required to be at least as great as per capita FFS expenditures in every county and are higher than FFS expenditures in many counties. For 2007, CBO calculates that benchmarks will be 17 percent higher, on average, than projected per capita FFS expenditures nationwide. Net payments to plans, which are reduced by 25 percent of the amount by which their bid is lower than the benchmark and adjusted for the expected cost of enrollees, will be approximately 12 percent higher than per capita FFS costs. Benchmarks are updated each year by either the growth in national per capita Medicare spending or 2 percent, whichever is greater.^(9),(10)

Geographic Patterns of Enrollment

The relationship between the cost of offering Medicare benefits and the benchmarks is an important determinant of the types of plans that are available in various areas of the country. To offer a product that is attractive to beneficiaries, a plan's cost of offering Medicare benefits must be low enough, relative to the benchmarks, to enable it to provide some combination of cash rebates and additional benefits. Those additional benefits--which generally are similar to the supplemental benefits offered by Medigap insurance--often include reduced cost sharing for medical services or prescription drugs. They may also include coverage of services that are not covered by Medicare, such as dental care, and they often include care coordination and disease management programs to promote better use of services.

HMOs and PPOs incur substantial administrative costs to establish and maintain networks of providers, to acquire and maintain enrollment, and to manage utilization. To the extent that they negotiate payment rates with providers that are higher than Medicare's payment rates for services furnished in the fee-for-service sector, those plans may also incur higher costs for medical services. Private health plans that participate in Medicare have higher administrative costs per enrollee than the traditional Medicare program does because of their smaller scale of operations and their costs associated with network development and retention, utilization management, disease management, marketing, and reinsurance. Private plans can provide Medicare services at a lower cost than the FFS program only if they can achieve savings through lower utilization or reductions in payment rates for providers that more than offset their higher administrative costs. The ability of plans to achieve such savings varies greatly across geographic areas.

Previous work by CBO has shown that plans' bids for operating Medicare Advantage plans vary less from county to county than per capita FFS spending does (see Table 1). As a result, in areas with high FFS costs per capita, Medicare Advantage plans' bids are relatively low in comparison with FFS spending, and vice versa. In particular, in areas with the highest FFS per capita spending, health plans' bids are about 10 percent below FFS spending. By contrast, in the lowest-cost FFS areas, health plans' bids are about 21 percent above FFS spending. Benchmark rates in those areas vary in similar fashion, from an average of about 4 percent above FFS costs in high-cost FFS areas to an average of about 26 percent above in low-cost areas.

Table 1.

That pattern of variation helps explain why most enrollment in HMOs and PPOs tends to be in relatively densely populated areas (where it is easier to establish provider networks) with relatively high benchmarks and generally high per capita FFS spending.⁽¹¹⁾ Private plans try to restrain medical costs by managing the level and intensity of service utilization. They have much greater potential to achieve savings relative to the FFS program in geographic areas where FFS practice involves relatively high utilization of costly services--which also tends to be areas with high per capita FFS expenditures. Private plans have much less opportunity to achieve such savings in areas where utilization rates for expensive services in the FFS sector are already relatively low.

In contrast to HMOs and PPOs, private fee-for-service plans do not incur the costs of establishing and maintaining networks of providers or managing utilization, and their payment rates generally are the same as Medicare rates. However, PFFS plans incur administrative costs for acquiring and maintaining enrollment, and they do not realize comparable savings from utilization management, which is often cited by supporters as an important public policy benefit from other types of Medicare Advantage plans.⁽¹²⁾

The structure of the payment system and plans' characteristics result in significant variation in the rebates returned to beneficiaries by region and county. HMOs are generally more successful in urban and suburban areas but struggle to operate in rural areas because of the difficulty and expense of creating provider networks in sparsely populated communities. PFFS plans generally target rural and suburban areas of the country. In many places, PFFS and regional PPO plans are the only options for beneficiaries wishing to enroll in private health plans because of the higher payment rates relative to FFS costs in those areas (particularly in the rural counties with benchmarks at the floor amounts⁽¹³⁾) and the lack of competition from HMOs in markets where it is difficult to establish provider networks. PFFS plans may also find it difficult to compete in urban areas where the benchmarks tend to be closer to FFS costs. In general, and despite their access to Medicare payment rates, PFFS plans are not able to offer rebates or supplemental benefits as large as HMOs can because of the higher cost of doing business in the plans' operating areas and their lesser control over utilization (relative to HMOs').

Anticipated Trends in the Medicare
Advantage Program

Increasing spending in Medicare Advantage is driven by rapidly increasing enrollment in private plans and is partially offset by decreasing enrollment and spending in FFS Medicare. Payments to private health plans in the Medicare Advantage program increased from about $40 billion in 2004 to about $56 billion in 2006. CBO projects that those payments will increase to $75 billion in 2007 and $194 billion by 2017 and will total $1.5 trillion over the 2007-2017 period.⁽¹⁴⁾ And because payments to Medicare Advantage plans are higher than payments made to FFS providers, the enrollment shift results in higher net costs for the program. CBO projects that the share of Medicare spending for Part A and Part B benefits that is paid to Medicare Advantage plans will increase from 17 percent in 2006 to 27 percent in 2017.

Increasing Enrollment in Medicare Advantage

In 2004, Medicare Advantage plans accounted for 13 percent of enrollment in Medicare, the lowest level since 1996. Over the past two years, however, enrollment in those health plans has increased to about 19 percent of all enrollment, or 8.3 million beneficiaries.⁽¹⁵⁾ That increase resulted from changes enacted in the Medicare Modernization Act that increased payment rates and added a prescription drug benefit to complement the medical benefits provided under Parts A and B of Medicare. CBO projects that enrollment in Medicare health plans will continue to increase rapidly in coming years, to 22 percent of total Medicare enrollment in 2008 and 26 percent by 2017 (see Figure 1).

Figure 1.

That projected increase is driven largely by CBO's expectation of continuing growth in enrollment in private fee-for-service plans, which rose from 200,000 members at the end of 2005 to more than 1.3 million members in January (see Table 2). Nearly 500,000 of those members were added in January 2007 alone. CBO projects that enrollment in PFFS plans will reach 5 million members by 2017, accounting for one-third of all Medicare Advantage enrollment at that time, up from about one-sixth now.

Table 2.

HMOs and local PPOs grew strongly in 2006, as well, adding approximately 1.1 million members from the end of 2005 to January 2007. Membership in such plans now numbers approximately 6.2 million. Growth in January 2007 was somewhat slower than that for 2006, however, and, according to CBO's projections, that portion of the program will grow more slowly than the PFFS portion over the next several years. In addition, the expiration of the authorization for the special needs program after December 31, 2008, will eliminate one of the fastest-growing components of local HMOs and PPOs, limiting the future growth of such plans under current law.⁽¹⁶⁾

The growth of PFFS plans has changed the geographic pattern of Medicare Advantage enrollment. In 2006, PFFS plans drew 39 percent of their membership from rural areas, while HMOs and local PPOs drew only 4 percent and 10 percent, respectively, of their membership from rural areas.⁽¹⁷⁾ The growth of PFFS plans increased the market share of private plans in rural areas from about 4 percent in 2005 to about 7 percent in 2006, and CBO expects that market share to continue to grow under current law.

Rising Costs for Medicare Advantage

CBO projects that payments to health plans will rise from an estimated $64 billion in calendar year 2006 to $197 billion in 2017, an annual average growth rate of 11 percent (see Table 3).⁽¹⁸⁾ Spending in Medicare Advantage is projected to total approximately $1.5 trillion over that 11-year period.

Local HMOs and PPOs are projected to constitute the largest portion of spending throughout the budget window. According to CBO's projections, payments to those organizations will increase from approximately $54 billion in 2006 to approximately $63 billion in 2007 and $127 billion in 2017, an annual average nominal growth rate of 8 percent. That increase results from projected annual average growth of 4 percent in enrollment and 4 percent in net per capita payments. Enrollment growth is more rapid in the early portion of the period, with projected growth of 11 percent for 2007.

CBO projects that private fee-for-service plans will account for a rapidly growing share of Medicare Advantage spending, with payments to them increasing from approximately $5 billion in 2006 to $13 billion in 2007 and $59 billion in 2017. That increase represents an annual average nominal growth rate of 25 percent over the 11-year period and reflects a 20 percent average rate of growth in enrollment and a 4 percent average annual rate of growth in net payments per enrollee. In 2006, PFFS plans accounted for approximately 8 percent of Medicare Advantage spending; CBO anticipates that those plans will account for 17 percent of that spending in 2007 and 29 percent in 2017.

Regional preferred provider organizations have experienced slower enrollment growth than CBO expected in the March 2006 baseline. CBO now projects that such plans will eventually grow from the current 120,000 members to about 800,000 in 2017 (under an assumption that current law remains in place). Payments to such plans were approximately $1 billion in 2006 and, by CBO's projections, will be $1 billion in 2007 and $10 billion in 2017--representing an annual growth rate of 8 percent, 4 percent from enrollment and 4 percent from growth in net per capita payments.

CBO's baseline projections also include approximately $3.5 billion in spending in 2012 and 2013 from the "stabilization fund" established under the Medicare Modernization Act to encourage regional PPOs' participation in the Medicare Advantage program.

Recent Changes in CBO's Projections

Enrollment in the Medicare Advantage program has been growing more rapidly than CBO had anticipated, and the agency now expects that rapid growth will continue under current law. Accordingly, since last year, CBO has raised its projections of Medicare Advantage enrollment and spending. In March 2006, CBO anticipated that 18 percent of Medicare beneficiaries would be enrolled in Medicare Advantage by the end of the projection window at that time (2016); the current projection for that year is 26 percent (see Table 4). That 8 percentage-point difference translates to an increase of almost 5 million beneficiaries who will be enrolled in Medicare Advantage plans in 2016.

Most of that increase is attributable to increased projections of enrollment in PFFS plans. In 2006, CBO projected that enrollment in those plans would be 400,000 in 2016; that projection has since risen sharply, to 4.9 million beneficiaries. CBO has also raised its projection of enrollment in local HMOs and PPOs but has lowered its projection of enrollment in regional PPOs.

The changes in CBO's projections of spending for Medicare Advantage are largely accounted for by the changes in projections of enrollment. The baseline issued in March 2006 projected spending for Medicare Advantage of $66 billion in fiscal year 2007, $134 billion in 2016, and $967 billion over the 2007-2016 period (see Table 4).⁽¹⁹⁾ CBO currently projects spending of $75 billion in fiscal year 2007, $179 billion in 2016, and $1.31 trillion over the 2007-2016 period. The current 10-year figure represents an increase of 36 percent over the previous 10-year figure. Because beneficiaries can be enrolled in only the Medicare Advantage program or the FFS program, increasing enrollment in the former leads to partially offsetting decreasing spending in the latter. However, because payments to Medicare Advantage plans are higher, on average, than costs in the FFS sector, shifts in enrollment out of the FFS program and into private plans increase net Medicare spending.
 

Estimated Spending Reductions from
Alternative Policies

A number of policy options exist that would reduce spending on Medicare Advantage. This testimony presents three options drawn from CBO's recent Budget Options report.⁽²⁰⁾

Pay Plans at Local FFS Rates

The first policy would reduce the county-level benchmarks under Medicare Advantage to the level of local per capita FFS spending. Relative to spending under current law, CBO estimates, this policy would save $8 billion in 2008, $65 billion over the 2008-2012 period, and $160 billion over the 2008-2017 period (see Table 5).

Table 5.

All counties have benchmarks set at or above local FFS rates. Many counties have rates well above local per capita FFS costs, particularly counties where the floor payment rates were in effect before the enactment of the Medicare Modernization Act. Reducing payment rates to FFS levels would result in a significant reduction in payment rates in most counties. CBO estimates that in 2007, the average payment will be 12 percent above FFS rates; that difference will be greater for PFFS plans and lower for HMOs and PPOs. The continuing growth of PFFS plans is likely to push that payment difference still higher in the future.

Reducing payment rates would leave less money for health plans to offer reduced premiums or supplemental benefits. That change, in turn, would make the program less attractive to beneficiaries and lead some to return to the traditional fee-for-service program. Others who would have joined Medicare Advantage plans would remain in the fee-for-service program. The change also would make the Medicare Advantage program less attractive for health plans and cause some to leave the program, as they did after the Congress cut payment rates in the Balanced Budget Act of 1997. By CBO's estimates, enacting this policy would reduce enrollment in Medicare Advantage by about 6.2 million beneficiaries in 2012 relative to the baseline projection, a decline of about 50 percent--leaving total Medicare Advantage enrollment at about 6.5 million (and the program's share of total enrollment in Medicare at 13 percent), about 1.8 million enrollees fewer than there are today.

CBO also has estimated the budgetary effect of variations on this option that would limit the benchmarks to certain levels above local FFS costs (see Table 6). For example, the Congress could limit all local benchmarks to 110 percent or 120 percent of local per capita FFS spending. Such policies would have similar, but smaller, effects on payments to plans and enrollment. CBO estimates that capping payment rates at 110 percent of local per capita FFS costs would reduce spending by $38 billion over the 2008-2012 period and $95 billion over the 2008-2017 period. Capping rates at 120 percent of FFS costs would save $18 billion from 2008 to 2012 and $45 billion from 2008 to 2017.

Table 6.

In general, those spending reductions mirror the spending distribution of Medicare Advantage payments. About 52 percent of Medicare Advantage spending is in counties where the benchmark is greater than 110 percent of local FFS costs, meaning that about one-half of spending would be affected (see Table 7). (That fact does not mean, however, that one-half of spending would be cut from the program, because the portion of spending below 110 percent of local FFS costs in those counties would be unaffected by the change. CBO anticipates that such cuts would lead to decreases in enrollment, bringing some additional savings as beneficiaries left private plans and returned to FFS.)

Table 7.

Eliminate Double Payments for Indirect Medical Education

Medicare's payments to teaching hospitals for inpatient services in the traditional fee-for-service sector include an "indirect medical education" (IME) adjustment. That adjustment is intended to account for the fact that teaching hospitals tend to have greater expenses than other hospitals. For example, teaching hospitals typically offer more technically sophisticated services than other hospitals do and treat patients who have more complex conditions.

Those IME payments are included in the benchmarks in counties where the benchmark equals per capita spending in the fee-for-service sector. Nevertheless, Medicare also pays the IME amount to teaching hospitals that treat patients enrolled in Medicare Advantage plans.

This policy would eliminate that double payment by removing IME payments from the benchmark in counties where the benchmark equals per capita spending in the fee-for-service sector. By CBO's estimates, such a change would save $1 billion in 2008, $5 billion over the 2008-2012 period, and $13 billion over the 2008-2017 period (compared with spending under current law).

This option is only one method of implementing such a payment reduction. The Administration's budget for fiscal year 2008 proposed an alternative approach: remove the double payments for IME in all counties (not just the FFS-based counties) by eliminating the separate IME payment for Medicare Advantage enrollees treated in teaching hospitals. The Administration's proposal would phase in that change over the 2008-2016 period. According to CBO's estimates, that provision would save $500 million in 2008, $5 billion over the 2008-2012 period and $19 billion over the 2008-2017 period. The choice of whether to eliminate the double payment from the health plan side or from the hospital side could have important financial consequences for health plans and teaching hospitals.

Eliminate the Remainder of the Regional PPO Stabilization Fund

The stabilization fund established by the MMA was authorized to spend $10 billion over the 2007-2013 period to encourage the participation of regional PPOs in the Medicare Advantage program. The Tax Relief and Health Care Act of 2006 repealed $6.5 billion of that amount and prohibited spending the remainder until 2012. This option would eliminate that fund and would save an estimated $1.6 billion in 2012 and $3.5 billion over the 2008-2017 period.
 

Conclusion

The Medicare Advantage program has been growing rapidly and is projected to continue to do so. Such growth, under current payment policies, increases net costs to Medicare because the evidence suggests that the payments made to Medicare Advantage plans exceed costs under the traditional fee-for-service program. Policymakers evaluating options for reducing payments to Medicare Advantage plans need to weigh the cost savings against any benefits that plans provide in managing utilization, the effect on health care costs overall, and the impact on beneficiaries.