Medicare Minus Choice

Report Health Care Reform

Medicare Minus Choice

September 1, 1998 13 min read
Carrie Gavora
Research Associate

Last year's Medicare reform, which included the first steps toward consumer choice and competition, is being undermined by bureaucratic red tape. The Health Care Financing Administration (HCFA), the federal bureaucracy that runs the Medicare program, announced on August 24, 1998, that it had received only three applications from health care insurers seeking to participate in the new "Medicare+Choice" program.1 The deadline for applications was August 31.

This new program was touted last year by Members of Congress and officials of the Clinton Administration as opening up unprecedented private health coverage options for America's senior citizens enrolled in Medicare. It now appears that, at least for its inaugural year, the "+Choice" part of the Medicare program has failed to materialize. A closer look at the law Congress passed, and at the agency charged with implementing it, shows why this is the case.

Another government program, on the other hand, has had no difficulty attracting private plans. Today, Members of Congress, congressional staff, and federal workers and retirees have access to hundreds of private health plans nationwide through the Federal Employees Health Benefits Program (FEHBP). Why the difference? The FEHBP has only a fraction of the rules and regulations applied to Medicare+Choice--red tape that apparently has choked off the supply of plans.

The FEHBP has attracted a variety of private health insurers since its inception over 38 years ago and today registers high levels of satisfaction among its millions of enrollees. The reluctance of insurers to offer plans under Medicare+Choice suggests that Members of Congress should take a leaf from their own book and amend the law and regulations to set up a similar consumer choice system for senior citizens that is free of bureaucratic micromanagement.

The Medicare + Choice Program

The Balanced Budget Act of 1997 (BBA) made some significant changes in Medicare. Among them was an expansion of the types of private health insurers that can contract with Medicare to provide benefits to seniors, as well as methodological changes in the formula used to determine how much the government would pay these insurers.

Before the BBA, only tightly managed health maintenance organizations (HMOs) could contract with the government under Medicare. The BBA expanded the program to include preferred provider organizations (PPOs), provider sponsored organizations (PSOs), point-of-service plans (POSs), private fee-for-service plans (FFSs), and a limited number of medical savings accounts (MSAs). In addition, Congress changed the payment formula for private health plans, known as the Adjusted Average Per Capita Cost or AAPCC, in an attempt to make payments to health plans better reflect local market prices for health care.

One reason insurers have been reluctant to participate in the Medicare+Choice program is the limited amount of time they have been given to study the complicated regulations governing participation. Although Congress passed the BBA over a year ago, HCFA did not publish the final regulations--covering 833 pages--until June 26 of this year, giving insurers little time to absorb the massive document and submit a proposal to HCFA by August 31.

But this short turnaround time is not the only difficulty. An examination of the new regulations shows fundamental problems facing insurers and consumers alike, such as the uncertainty of the regulatory process and the substantial costs of complying with HCFA's onerous and often unnecessary rules and regulations.

With 38 million beneficiaries, the sheer size of this market would seem to be enough to tantalize any private health insurer. Insurers who wish to participate in Medicare+Choice, however, must accept significant barriers and government micromanagement as the price of that participation. Among the many such challenges faced by these insurers are government standardized benefits, price controls, HCFA's micromanagement of service areas, and burdensome data collection and reporting requirements.

Government Standardized Benefits

Congress requires all health plans contracting with Medicare to cover the Medicare standard benefits package, which includes new mandates for coverage of preventive health services added to the program in the BBA. Government-dictated health benefits not only deny consumers choice by imposing a one-size-fits-all standard on health benefits, but also inhibit the ability of insurers to respond to consumer needs by marketing different products at different prices to consumers.

Traditionally, many seniors found Medicare HMOs attractive because these organizations were able to offer a variety of benefits to beneficiaries that Medicare did not cover, especially prescription drugs. But as Congress mandates more benefits while holding payments to health plans at the same or, in many cases, lower levels, health plans are less able to tailor affordable products to seniors' needs. In fact, at the beginning of this year--before BBA payment and benefit changes even took effect--Medicare HMOs in California, Maryland, New Jersey, and Pennsylvania announced premium increases and/or benefit cutbacks.2

In addition, President Clinton, by Executive Order, recently required all health plans contracting with Medicare to comply with his "Consumer Bill of Rights and Responsibilities." These additional mandates (which were not authorized by Congress) include access to specialist services for people with chronic conditions, requirements for provider credentialing and timeliness of coverage, ensuring the "cultural competency" of providers, direct access to women's health specialists, and the completion of a baseline health assessment for all new enrollees within 90 days of coverage. Moreover, HCFA has imposed spending limits without congressional authorization by limiting beneficiary cost-sharing to $50 if an enrollee visits an emergency room out of a health plan's network area.3

Price Controls

Medicare attempts to manage its finances through government price-setting rather that market competition. In traditional Medicare, payments to doctors are based on a complicated formula called the resource-based relative value scale (RBRVS), which in turn provides the inputs for the physician fee schedule. Both of these formulas are subject to constant tweaking and meddling by policymakers. When Medicare contracts with private HMOs, another formula is used (the AAPCC) that attempts to measure local and national per capita costs and blend them to come up with a specific dollar amount that Medicare will pay per HMO enrollee.

Medicare's price controls have had a dreadful record in holding down program costs. As often happens when prices do not reflect the relative supply of or demand for services, Medicare's price controls force providers to shift efforts and attention to areas in which these controls do not exist, sending Medicare spending through the roof (as was evident in the Medicare Part A home health program).

This failure to hold down costs also is evident in the Medicare contracting program, where HMOs were paid 95 percent of the average Medicare fee-for-service costs. The assumption was that the government would save 5 percent. Of course, this did not happen. This policy had the effect of overpaying many HMOs in areas with high concentrations of Medicare fee-for-service enrollees and encouraged health plans to seek out healthy seniors.

Although Congress's tinkering with this formula in the BBA may remove some of the previous irrationality, it adds to the confusion surrounding the new program, further discouraging insurers from offering plans. This type of price-setting also invites new distortions in the future.

Health Plan Service Areas

The BBA requires that private health plans charge the same premium and provide the same benefits to everyone within a defined "service area." Before the BBA, Medicare allowed HMOs whose service areas crossed a number of different counties with different AAPCC rates (which are defined by county) to vary premiums and benefits by county (so-called flexible benefits). This new uniformity requirement poses significant challenges to insurers interested in entering this market, particularly for rural health plans.

What is more, HCFA has the discretion to deny the designations of health plan service areas proposed by insurers for a variety of reasons, including a belief by officials that a health plan is attempting to avoid providing coverage in high-cost areas. This concern and the debate that surrounds it are eerily reminiscent of the futile debate over designing boundaries for the government-sponsored regional health alliances in the 1993 Clinton health plan.

In testimony before the Senate Finance Committee, Jim Paquette, CEO of the Sisters of Charity of Leavenworth, Montana, Region, had this to say about the new Medicare rules to govern health plan service areas:

It is difficult for a plan to provide the same benefit throughout a service area without receiving the same payment for each plan member in that area.... Plans have three approaches to resolving this problem under the new rules: reduce benefits in higher-rate areas to cross-subsidize lower-rate areas; pull out of lower-rate areas (rural areas); or seek HCFA approval of multiple M+C plans offered by the same M+C organization.4

Paquette went on to say that while the uniformity requirement may have been well intended, he is concerned that the real impact will be felt by seniors residing in rural areas who will have few, if any, health plan options.

Limiting Consumer Choice

Perhaps the most daunting challenge facing health plans is compliance with a host of new performance standards. Insurers have raised concerns about HCFA's intention to apply data collection and quality improvement standards that would discriminate against certain types of health plans and would place unprecedented administrative burdens on all plans contracting with Medicare.

In particular, insurers are concerned that a seemingly innocuous provision requiring the collection of standardized plan data on quality indicators and health outcomes would have the adverse affect of requiring all forms of managed care to operate more like HMOs. HMOs generally have structures for collecting this type of information to help them manage patient care better, and often have information systems in place that make these efforts less burdensome. But managed care products like preferred provider organizations are less "managed" by the insurer in that they offer open access to providers and minimum, if any, care coordination by primary care "gatekeepers." In the case of PPOs, the level of data collection and case management necessary to measure health outcomes would be exceedingly difficult and would force insurers to rewrite very detailed contracts with their affiliated providers to require them to meet these new demands for information-gathering.

In testimony before the Senate Finance Committee, Dr. Daniel Lestage, Vice President of Blue Cross/Blue Shield of Florida, remarked that, "Ironically, far from increasing choice to reflect options in the private sector, the Medicare+Choice regulations might end up restricting choice for Medicare beneficiaries."5 Some bills before Congress today, however, purport to protect patients from managed care but would apply the same standards to all private managed care plans.

Let Consumers Choose

Over a year ago, as Congress debated Medicare reform, The Heritage Foundation published a series of papers recommending that seniors be allowed the same kind of choices that Members of Congress, their employees, and all federal workers enjoy in the Federal Employees Health Benefits Program. The FEHBP is virtually the only health system in the country in which individuals and families can choose the kinds of benefits and insurance plans they want at the prices they wish to pay.6

Many have characterized the reforms made in the BBA as FEHBP-like, but these changes miss the consumer-choice mark in a number of key areas.

  • Unlike Medicare+Choice, the FEHBP does not impose a rigid standardized set of health benefits. Health plans are required by law to offer certain categories of benefits, such as inpatient and outpatient care; they can vary specific benefits to better accommodate individual enrollees' needs. Benefits change each year as a result of a sensitive and confidential negotiating process in which private-sector plans come to mutual agreement with the negotiating staff at the Office of Personnel Management (OPM), the agency that administers the FEHBP. Consumers can, and do, choose from a wide variety of benefit packages, with different medical treatments and procedures at different premium levels and different copayments. In addition, the FEHBP allows union and association-sponsored health plans to compete.

  • Unlike Medicare+Choice, the FEHBP does not use price controls. Every year, the health plans submit bids to the OPM, which then fine-tunes these bids in a negotiating process with the various plans. Based on the negotiated price of a health plan's contract, the government then determines its contribution to the health plan chosen by the federal employee. The government's portion of the premium is capped--an enrollee who chooses a more expensive plan with a richer set of benefits will have to pay more out-of-pocket for those benefits.

  • Unlike Medicare+Choice, the FEHBP does not define service areas within which health plans must provide coverage. As Jim Morrison, former OPM Associate Director of Compensation, says, "Service areas are not an issue" in the FEHBP.7 Health plans contracting with the OPM determine the area they want to cover. The problems health plans will face when contracting with Medicare+Choice have less to do with how boundaries are defined than with how Medicare determines payments for health plans. As already noted, Medicare payments to private plans are determined by a formula and made on a county-by-county basis. This can cause wide variation from one county to the next--hence the concern about how service areas are defined. The FEHBP does not have this problem because payments to health plans are negotiated with individual health plans based on their experience in a given area of operation.

  • Unlike Medicare+Choice, the FEHBP does not discourage private insurers from entering the market by requiring onerous data-collection and mandated quality assurance programs. This issue throws into sharp relief the defining difference between Medicare+Choice and the FEHBP: how they are structured to operate. In the FEHBP, quality is driven by competition between health plans, not oppressive regulation and government oversight. Plans are not required to have private accreditation, but many do receive it and then advertise that fact to enrollees to gain a competitive edge. In the FEHBP, consumers choose the plans they want based on enrollee-reported quality indicators, private accreditation, price, and a host of other considerations that are readily available in privately produced consumer guides, notably a popular and easy-to-read booklet published by the Center for the Study of Services, a consumer organization, called Consumers' Checkbook, and on the Internet. If they do not like what they have chosen, they have an opportunity each year to change plans.


The Medicare+Choice program's experience during its first year will provide a telling lesson for Congress and the Medicare Commission, which is charged with determining solutions to Medicare's long-term financial problems. So far, however, it does not look as if that lesson will be a positive one, with Medicare transformed into a consumer-driven, competitive health system. Rather, it seems more likely that the lesson will be a negative one: that when Congress and HCFA decide to micromanage choice with hundreds of pages of rules and regulations, the consumer ends up with no choice.

Congress should take that lesson to heart, comparing Medicare+Choice with its own lightly regulated FEHBP--which offers a wide range of choices--and remove the suffocating red tape that is frustrating attempts at Medicare reform.

--Carrie J. Gavora is a former Health Care Policy Analyst at The Heritage Foundation.



1. Steve Teske, "HCFA Receives Only Three Applications for New Medicare+Choice Option," Bureau of National Affairs, Daily Report for Executives, No. 163, August 24, 1998, p. A13.

2. Milt Freudenheim, "Medicare H.M.O.'s to Trim Benefits for the Elderly," The New York Times, December 22, 1997.

3. HI Wire, "Medicare+Choice Interim Final Regulations: Summary and Analysis of Major Provisions," Health Insurance Association of America, July 7, 1998.

4. Prepared testimony of Jim Paquette, CEO, Sisters of Charity of Leavenworth, Montana, Region, before the Committee on Finance, U.S. Senate, July 30, 1998.

5. Prepared testimony of Daniel Lestage, M.D., Vice President, Blue Cross/Blue Shield of Florida, before the Committee on Finance, U.S. Senate, July 30, 1998.

6. Unfortunately, Congress and the President have imposed mandates on the FEHBP that inhibit its ability to operate in an efficient, competitive manner and threaten its success as a consumer-driven health care marketplace. These mandates include the President's "Consumer Bill of Rights and Responsibilities" and, more recently, the requirement by Congress that all FEHBP plans cover contraceptives.

7. Telephone conversation with the author, August 28, 1998.


Carrie Gavora

Research Associate