Will the Senate's Medicare PPO Program Work? 
Centists.Org Commentary
By Jeff Lemieux
6/11/2003

The Senate has answered the question of whether or not its proposed drug-only coverage will work.  The Grassley-Baucus proposal says in effect:  "If it doesn't work, the government will just take the risk and do the job." 

However, the main element of reform in the proposal, the new Preferred Provider Organization (PPO) program, could fail to get off the ground because of arcane "scoring" or cost-estimating contortions.  Rather than beefing up the promised drug benefits to buy votes, the Senate should first make sure the proposal's core element of reform would actually work.


One the legends of democratic government is that although each step of the the legislative sausage-making process can create a pretty disgusting product, in the end, after all the give and take, the final outcome is usually good.

That legend was from a different time.  Now, compromises are made before legislation is even drafted.  Most Senators and Representatives rarely have a chance to read a thorough analysis of the proposals they must approve or reject.

Moreover, the hastened process can lead to estimate-based legislating.  To hit "scoring" numbers, or to simply get an official estimate so the legislative process can move forward, Congressional drafters must tailor their proposals in particular ways.

For example, the Congressional Budget Office (CBO) has had difficulty estimating the impact of market-based Medicare reforms.  It has had less difficulty estimating the cost of stand-alone drug benefit proposals.  That is one of the reasons Congress has made more progress on a stand-along benefit than on other types of benefits or reforms.

Now, an unusual CBO estimating convention has prompted a potentially fatal problem in the PPO program, the main element of reform in the Senate Medicare compromise.  Under the proposal, seniors could purchase PPO coverage -- like that commonly offered by Blue Cross/Blue Shield plans -- in various regions of the country.  The PPO plans would offer seniors lower copayments for health services provided by "in network" doctors and hospitals, but would also allow them to go "out of network" to obtain services, provided they paid a higher level of coinsurance or met higher deductibles. 

Health providers sign up with PPOs, and accept lower fees or payments, because PPOs steer patients to them.  Patients are more likely to seek out doctors or hospitals on the "in network" list because their copayments would be less.  Also, PPOs try to ensure that in-network providers meet other criteria, such as high quality or reduced numbers of errors or complications.

However, the Grassley-Baucus proposal requires the Medicare program to choose no more than three such PPO plans in each region.  Presumably, CBO's thinking is that having fewer PPOs in each region would strengthen the plans' market power in negotiations with local health providers.  Therefore, CBO estimates that the proposal's overall costs would be lower if the number of PPOs were limited.

By implication, CBO estimates that having more than three PPOs in a region would dilute their collective market power, and would thereby cost the government more. 

Alternatively, CBO may be assuming that PPO programs inherently cost money, and that a requirement that only three plans participate would effectively discourage ANY plans from participating, for fear their investments in forming networks would come to nothing if Medicare selected three other plans.

Setting aside the technical specifications of exactly how Medicare would pay PPOs, CBO's general economic logic seems faulty in either case.  In the first case, CBO thinks that fewer PPOs would have greater market power to extract better deals and discounts and discounts from health providers, and thereby allow lower reimbursements from Medicare. 

But the longer-term dynamics of a system where Medicare picked only three participants could actually lead to HIGHER costs than letting seniors pick from an unrestricted menu of options.

Medicare is likely to make its initial picks based on objective criteria.  But over time, the interaction between the contractor (the favored PPO) and the government would probably become locked in place.  Typically, government programs are loathe to change contractors even if their performance over time is poor.  Dominant contractors can get too comfortable, and lose their innovative edge.  Rivals may just divide up markets for their mutual benefit, but not necessarily for the long-run benefit of seniors or taxpayers.

By contrast, allowing an unrestricted number of PPOs might seem more chaotic in the first year.  But letting the market sort out the winners and losers based on enrollment patterns, not a bureaucratic selection process, would probably create both better outcomes and lower costs over time.

CBO's alternative reasoning -- that all PPO options are inevitably cost-increasing, and that limiting their enrollment necessarily reduces Medicare's costs -- is also questionable.  CBO correctly assumes PPOs pay higher fees to doctors and hospitals than Medicare's traditional fee-for-service system right now.  (The market dynamics of PPO reimbursement rates change over time -- currently health providers have market advantages and have negotiated higher reimbursements than Medicare generally pays.)

But that doesn't mean PPOs necessarily cost more.  The prices they pay might be higher, but if the quantity of services their members demand is lower, or if the type or quality of services their members receive is more cost-effective, their overall costs wouldn't necessarily be higher than Medicare's.  It may seem unlikely that PPO's in-network providers could be successful enough at providing higher quality care or reducing unnecessary health utilization to offset their current price disadvantage, but it's not impossible. 

Moreover, the current price disadvantage faced by PPOs may switch back to a price advantage over the next several years.  (In the mid-1990s, PPOs and HMOs had enormous market power and extracted large payment concessions from health providers.) 

Finally, a robust PPO program in Medicare, along with a revitalized HMO program, is probably essential before Medicare can switch its operations toward a widespread consumer choice system.

In the long run, a consumer choice system, possibly patterned after the Federal Employees Health Benefit (FEHB) program, offers the best chance for a permanent slowing of Medicare's spending growth.  CBO's estimates do not include this potential savings because the proposal at hand doesn't implement a full consumer choice system.  But it would be helpful if CBO's analysis acknowledged the possibility, so that legislators could evaluate the long-term implications in addition to the short-run technical estimates.

To be fair, CBO's estimates are not yet published, and their logic could be stronger or more appropriate than we know.  However, given that Medicare and entitlement policy for the next decade (or longer) is at stake, we feel no hesitation to ask Congress to base Medicare policy on higher principles, and to disregard quirky, short-term estimates that may produce counter-intuitive or unworkable results.

Congress should allow any PPO plans to give the Medicare market a try.  It should not allow a CBO estimating rule to dictate an unworkable policy.