Executive Summary

The Senate Finance Committee recently passed, by a vote of 16 to 5, the Prescription Drug and Medicare Improvement Act of 2003. The unnumbered bill is scheduled for Senate floor consideration starting immediately.

The Senate bill's provisions cover the creation of a universal Medicare Prescription Drug Program under a new Part D (Title I); the replacement of the Medicare+Choice (Part C) program with a new Medicare Advantage program under Part C (Title II); the creation of a Center for Medicare Choice (Title III) that would administer Part C and Part D of the Medicare program; the addition of miscellaneous amendments to the existing Medicare fee-for-service program, including reimbursement updates for medical facilities in rural areas (Title IV); and several provisions for Medicare regulatory relief (Title VI).

This analysis is based on a descriptive outline of the Senate bill's provisions; it is not based on formal legislative language, which has been unavailable to the public.[1] This analysis focuses only on the provisions of Title I, Title II, and Title III. The analysis also does not reflect Senate Finance Committee amendments to the draft outline, including the changes in the out-of-pocket limits on the standardized drug benefit. (The Committee revised the drug benefit slightly: it will retain the originally proposed $35 per month premium, the $275 deductible, but it will extend the payment of 50 percent of the drug costs up to an annual amount $4500. At a total cost of $5813 in drug expenses, the government would assume 90 percent of the costs of the benefit.)

The New Medicare Drug Benefit. The basic structure of the drug benefit is traditional Medicare: cost-plus payments to private drug plans - exactly the way Medicare started out paying doctors and hospitals in 1965. While, in theory, there will be "risk-bearing" drug plans, assuming that plans come forward and participate, the actual share of the risk that they will bear will be limited if not marginal. In fact, their risk exposure will be more like that of a hospital's risk exposure with respect to Medicare payments for DSH and DRG outliers, than the risk exposure of a true insurance plan.

As a rough estimate, the "risk-bearing" plans (drug only and Medicare Advantage) would be liable for, net, no more than about 20 percent of the total risk (combined price and volume risk) of the benefits they cover.

The Senate Finance bill also creates "fallback" plans. The proposed "fallback" plans would not be risk-bearing entities (pure cost-plus financing) and thus Medicare (the taxpayers) would bear the full, combined price and volume risks for those enrollees.

The "fallback" plans will be pharmacy benefit managers (PBMs) functioning as "fiscal intermediaries" with the added twist that they have the power to negotiate prices and restrict access. This raises an obvious concern. It will likely not be long before this flexibility for the PBMs is replaced with uniform price schedules and coverage rules. Also, it is not clear from the legislative text why any PBM would become a "risk-bearing" plan.

Nowhere is the word "profit" mentioned in Title I, while distinctions between claims costs and administrative costs appear throughout the program design. By inference, any profit will consist of a couple of percentage points in the plans' administrative cost allowance. Even drug plans that are successful in keeping actual claims costs below projected claims cost will not see those savings as profit. First, standard prudent insurance practice is to retain them as reserves against possible spikes in future claims. Second, they will have to share those savings with Medicare. Third, in the first five years, Medicare will escrow any savings above 3 percent in a "stabilization reserve fund" which will be in addition to the normal reserve funds the plans are expected to keep on their own. Thus, profits for both risk bearing and non-risk-bearing plans must come from the administrative cost allowances they negotiate with Medicare. This is basically cost-plus financing.

Separate Drug Payments and "Risk Corridors." Also, the new Medicare Advantage plans (created under Title II) will be paid separately, and be required to do detailed separate accounting so that the government officials can adjust their payments for the drug component of their comprehensive coverage. In the case of those plans, this will exacerbate the very problem that the original premium support approach (for example: the 1999 Breaux-Thomas proposal and its various successors) was designed to correct - the component management and line item reimbursement that generates fragmented, episodic care.

Particularly troublesome are the provisions in the "risk corridor" and "reinsurance" sections designed to recapture payments when a plan "overpays," relative to the national average price negotiated by all plans, for a specific drug. This provision will likely keep out-or force out-drug plans that don't think they have enough market share to get the best deal among all the plans nationally (not just the ones they compete against in their chosen area). It will also induce uniform pricing by manufactures-no more competition for discounts.

Finally, to administer the "overpayment recapture" provisions, Medicare will need to collect all the price and volume data from all the plans for each and every drug, for each and every prescription, and for each and every beneficiary. This provision contains its own political dynamics: it is inevitable that Medicare officials or members of Congress will aggregate that data, and develop a list of how much Medicare spends in total on each specific prescription drug. This will inevitably lead to congressional hearings targeting the high cost/high volume drugs that are costing Medicare the most money. These political pressures will in turn trigger demands for the inevitable "cost containment" (price and access control) legislation.

In summary, Title I creates a new Medicare drug program, delivered through private drug-only plans, in which the taxpayers will be liable for more than 80 percent of the total risk of the total drug benefit. The fiscal pressures are likely to trigger demands for price and access controls to control costs. Meanwhile, the structure of the benefit is such that its incentives actually work against integrating drug coverage into the kind of coordinated, chronic-care delivery model that most health policy experts view as the essential reform needed to improve medical care for senior citizens.

The Medicare Advantage System. Title II of the bill creates a new system of health plans, replacing the flawed "Medicare+Choice" experiment with the new " Medicare Advantage" program. Title III creates the Center for Medicare Choice.

In some respects, these titles may be intended to resemble the popular and successful Federal Employees Health Benefits Program (FEHBP). Medicare Advantage is a system of competing private plans; government payment is made to these plans on behalf of the Medicare beneficiary; and an Administrator who will negotiate and enforce contracts with private plans administers the program.

In crucial respects, however, this proposed program does not resemble the FEHBP. In the FEHBP, there is no government-standardized drug benefit or system of drug-only plans, like there is proposed in the Senate bill. In the Senate bill, there is a strongly enforced comprehensive standardization of benefits, including drug coverage, which is not found in the FEHBP. The formula for payment to private plans in Medicare Advantage is based largely on Medicare's system of administered pricing, while in the FEHBP the government payment is based on the weighted average premiums of plans in a real competitive market. In Medicare advantage, the government limits the number of Preferred Provider Organizations (PPOs) that may compete in any given region of the country to three, while in the FEHBP there is no such limit.

Perhaps the most important difference between the program developed in the Senate draft and the FEHBP is likely to be the governance of the program, specifically the breadth and reach of government regulation. The statutory language that governs the FEHBP, a program that covers roughly nine million federal workers and retirees and their dependents, is a little more than 40 pages long. The administration of the program is decentralized; it is largely undertaken by the private health plans themselves under Office of Personnel Management (OPM) oversight. Most of the heavy lifting in the program is accomplished through the free market forces of consumer choice and competition. That is why it has been a success, in sharp contrast to the Medicare+Choice program, which has been a regulatory nightmare.

In Medicare Advantage, the intricacy of the statutory provisions, and the breadth of regulatory authority given to the Administrator of the Center for Medicare Choice, is very broad and potentially very deep, while in the FEHBP, OPM's statutory language is comparatively sparse and its specific mission in regulation is to carry out the limited responsibilities entrusted to it in Chapter 89 of Title V and, in regard to health plans specifically, to set "reasonable minimum standards" for health plan participation. That is what OPM does. There are less than 100 pages in the Code of Federal Regulations governing the FEHBP.

In the Medicare Advantage system, the relationship between the Administrator and private plans is likely to be a regulatory relationship, similar to that found in the flawed "Medicare+Choice" program; in the FEHBP, the relationship between OPM and private plans is, and throughout its 43-year history generally has been, a business relationship. It has been historically a successful and fruitful one, yielding high quality of care and a high degree of satisfaction for millions of federal workers and retirees and their families, including many retired federal workers who are not covered by Medicare and thus get all of their health care benefits through FEHBP.

TITLE I - THE DRUG BENEFIT

Part I - Basic drug benefit structure

Section 1860D6:The Standard Coverage Requirement. The standard coverage has a "doughnut hole." However, entities could offer plans with more generous coverage, provided they also offered the standard coverage package. They could also offer actuarially equivalent plans with different cost sharing. But to do so,"the actuarial value of total coverage would have to be at least equal to the actuarial value of standard coverage. The unsubsidized value of coverage would have to be at least equal to the unsubsidized value of standard coverage. Further, the coverage would be designed, based on a representative pattern of utilization, to cover the same percentage of costs up to the initial benefit limit as provided under the standard plan. The limitation on out-of-pocket expenditures would be the same as under standard coverage. The entity would have to apply for and receive approval from the Administrator for an alternative benefit design."

Analysis: This is an overly prescriptive approach. It makes it less likely that the proposed entities will seek to offer actuarially equivalent coverage.

Section 1860-D-6:Coverage Breakpoints. The coverage breakpoints ($276 deductible, $3,450 initial coverage limit, $3,700 in out-of-pocket costs triggering 90 percent coverage) would be indexed, "in future years by the percentage increase in average per capita expenditures for covered drugs for the year ending the previous July."

Analysis: This is a reasonable benchmark to use for indexing and to restrain growth in program expenditure, if one assumes that one should index these elements uniformly.

Section 1860D:Covered Drugs. Covered drugs would be all drugs, biologics and insulin covered under Medicaid, except for smoking cessation agents and drugs covered under Medicare Parts A&B, plus vaccines licensed under Section 351 of the PHSA. (1860D - Definitions) Drugs covered by Medicare Parts A&B would still be paid for by those parts of the program.

Analysis: This appears to be a reasonable definition of "covered drugs." For the future, it may not be prudent for Congress to limit its definition of "covered" drugs to the current statutory definitions.

Section 1860D:Medical Necessity. Also, "coverage would be extended to any use of a covered drug for a medically accepted indication." Individual plans could exclude drugs as part of their formularies or on grounds that their use did not meet Medicare's definition of "reasonable and necessary."

Analysis: This appears to mean coverage would extend to generally accepted off-label uses, which is consistent with private practice.

Section 1860D-6: Best Price Exclusion. "The bill would exempt any prices negotiated by a Medicare Prescription Drug plan, Medicare Advantage plan, or qualified retiree program from Medicaid's determination of "best price" for purposes of the Medicaid drug rebate program."

Analysis: This is a sound provision, since it allows manufacturers to offer discounts in this market without fear that they will trigger larger Medicaid rebates.

Section 1860D-2: Beneficiary Choice of Coverage. Beneficiaries choose coverage when they become Medicare eligible, or later if they initially choose to retain other, equivalent coverage through a private retiree coverage plan, Medicaid, a state pharmacy assistance program or VA, and their coverage is then either discontinued or scaled back to be less than the "standard" coverage in Part D. Enrollment is similar to that of Part B with penalties for late enrollment. Once initially enrolled, beneficiaries would be able choose coverage annually.

Effective Date of the Part D Drug Program. The new Part D drug program would go into effect January 1, 2006. Between January 1, 2004, and June 30, 2006, the Centers for Medicare and Medicaid Services (CMS) would operate a "transitional" prescription drug discount card program for Medicare beneficiaries. (The program is essentially what the Administration attempted to do last year without legislation.) In addition, the cards would be accompanied by $600 per year in subsidies for beneficiaries "meeting the definition of QMB, SLMB, or QI-1, who were not eligible to receive drug benefits under Medicaid. … Beneficiaries would be subject to cost-sharing requirements which could not be less than 10% of the negotiated price for a drug. Cost-sharing charges would not count against the $150 available per calendar quarter. The Secretary would establish procedures whereby spouses, both of whom were enrolled in drug assistance card programs, could use the benefits on the other spouse's card. At a minimum, card sponsors would provide low-income enrollees with a minimum of a 20% discount from the average wholesale price for each covered drug." (Sec. 1807A)

Analysis: The card program and subsidies would be eliminated 6 months after the new Part D coverage took effect. This is odd, since the drug card and the subsidies for low-income beneficiaries is one of the most reasonable features of the legislation. Instead of sun-setting this provision, it should be retained as the "fallback" alternative in areas where seniors lack the option of choosing from competing drugs plans.

Part II - The Selection of Drug Plans

Section 1860D-6: The Process of Selecting a Drug Plan for Participation. The new Center for Medicare Choices (CMC), created under Title II, would divide the country into at least 10 "service areas" in which plans will be offered. (1860D-10)

Entities can offer plans with either the "standard coverage" cost-sharing structure, with a more generous cost-sharing structure, or with a cost-sharing structure that is different from, but actuarially equivalent to, the standard coverage cost-sharing structure. The standard cost-sharing structure and any actuarially equivalent cost-sharing structures are termed "qualified coverage." (1860D-6)

Plans seeking to participate would need to be licensed as risk-bearing entities in the states in which they will offer coverage, or have that requirement waived by CMC, and meet a variety of operational standards with respect to issues such as: solvency, reserve requirements, pharmacy network adequacy, out-of-network pharmacy access, the use and structure of formularies, the makeup and decision-making processes of the pharmaceutical and therapeutic (P&T) committees that create formularies, programs for drug utilization management and medication therapy management, consumer information, beneficiary appeals processes, privacy of medical records, etc. (1860D-4, 5, 7)

Plans seeking to participate must also submit bids to CMC. (1860D-12) The bids must include:

1. A description of the plan benefits;
2. The actuarial value of the "qualified coverage" portion of the plan benefits;
3. The service area in which the plan will be offered (could be one of the CMC defined service areas or could be nationwide, and plans can submit separate bids for each of several different service areas);
4. The monthly premium, subdivided according to the portions that constitute:
6. The standard coverage or an actuarial equivalent
7. Benefits in excess of the standard coverage
8. Premium reductions attributable to reinsurance payments to the plan from CMC (does not specify whether prospective or retrospective, but is presumably retrospective like DSH and DRG outliers);
9. Any plan to use funds available to the entity in the "stabilization reserve fund" to reduce enrollee premiums.

CMC reviews bids and, for both the standard coverage and additional coverage, is required to apply the FEHBP standard (embodied in Section 8902 of Chapter 89 of Title V) that each bid, "reasonably and equitably reflects the cost of the benefits provided."(1860D-13) CMC would have authority to negotiate terms, conditions, and premiums and would need to be satisfied that the plan design "would not result in favorable selection of beneficiaries." Then CMC approves or rejects each bid.

Analysis: There is no limit on how many drug plans CMC can approve to be offered in any service area, nor is there any provision that if a plan meets a specific set of requirements CMC must automatically approve it. Thus, CMC seems to have considerable discretionary authority in approving plans, since it could cite failure to meet any one of the foregoing provisions (most of which are at least partly subjective) as a reason to reject a plan. (1860D-13)

Part III - How Medicare Will Pay Private Drug Plans

Section 1860D-14: Payment of Private Drug Plans. All of the payment provisions outlined below would apply to both drug-only plans and to the drug portion of the newly proposed Medicare Advantage plans. The process is as follows:

1. CMC computes the premium amount for the qualified coverage portion (i.e., standard coverage or an actuarially equivalent alternative) of each private plan (both drug only and Medicare Advantage). (1860D-14)
   
2. CMC computes a monthly national weighted average premium for the standard coverage. The weighting is based on the previous year's enrollment in the various drug-only and Medicare Advantage plans. (1860D-15)
   
3. CMC creates a budget neutral, geographic risk adjustor for plan payments to "account for differences in prescription drug prices across service areas." (1860D-16)
   
4. CMC creates a budget neutral, actuarial risk adjustor for plan payments to account for "variations in costs based on the differences in actuarial risk of different enrollees being served." (1860D-11)
   
5. Thus, each plan is paid according to the following formula: Plan payment = (monthly plan premium * number of enrollees) * (geographic risk adjuster percentage + actuarial risk adjuster percentage). (1860D-16)
   
6. The risk-adjusted plan payments would then be further adjusted up or down, retrospectively, based on how actual claims costs compared to projected claims costs using a "risk corridor" mechanism. (1860D-16)
   
7. Each year CMC would establish a prospective "target" payment amount for each plan, "defined as the total of plan premiums minus a percentage (negotiated between the Administrator and the entity) for administrative costs." (1860D-16) Thus, the "target" payment amount equals the anticipated total claims costs for each plan.
   
8. CMC applies a set of "risk corridors" to each plan's "target" amount. (1860D-16) The risk corridors are narrower in the first years, expanding to thresholds of +/- 5% and +/- 10% from 2011 onward. Thus, from 2011 onward, if a plan's actual claims costs were:
10. Between 95% and 105% of the prospective "target" the plan would either keep the savings or absorb the loss.
11. Between 105% and 110% of the target, CMC would pay a percentage of the additional costs.
12. Above 110% of the target, CMC would pay an even larger percentage of the additional costs.
13. Between 90% and 95% of the target, the plan would have to pay back to CMC a portion of the savings.
14. Below 90% of the target, the plan would have to pay back to CMC a different portion of the savings.
    
15. However, before calculating the payment effects of the risk corridor provisions for any given plan, CMC would first make yet another adjustment. CMC would adjust the plan's reported claims costs, "in cases where the actual costs for a covered drug exceeded the average negotiated price for such drug in the year." (1860D-6) Thus, individual plans would be penalized for "over-paying" for specific drugs relative to the national average price paid for the drug by all plans.
    
16. CMC would also compensate plans with reinsurance payments for individual high-cost beneficiaries, defined as those whose drug spending exceeded the out-of-pocket limit. Payments would equal 80 percent of the expenses above the beneficiary's out-of-pocket limit, after reducing the plans actual costs by the amount (if any) that the plan "overpaid" for specific drugs for the specific beneficiary. (1860D-20) Thus, individual plans would be penalized for "over-paying" for specific drugs for specific, high-cost beneficiaries, relative to the national average price paid for the drug by all plans for all beneficiaries.
    
17. For the first five years of the program (2006-2010), CMC would create and operate a "stabilization reserve fund." Any savings of 3 percent or more in actual claims costs relative to the plan's target would be kept by CMC and placed in a "stabilization reserve fund" account for the plan. Then, starting in 2008, the plan could draw down any savings it had accrued to offset increases in the plan's actual costs for the years 2008-2010, and thus "stabilize" the plan's premiums for those years. The accounts would terminate after five years. (1860D-16)

Analysis: The provisions for recapturing "overpayments" for specific drugs in the calculation of risk corridor and reinsurance payments would have a number of effects, as can be seen from the following hypothetical example:

A drug plan has an anticipated claims cost target of $1,000,000, but actual claims costs come in at $1,060,000. In theory the plan would have to eat $50,000 of its $60,000 loss, since that is within the +/-5 percent risk corridor, and CMC would pay part (50 percent in this example) of the remaining $10,000 of the loss. Thus total CMC payments would be $1,005,000 and the plan's net loss would be $55,000.

But in reviewing the prices paid and the volume purchased for each drug by the plan, CMC determines that the plan paid a total of $10,000 for drug X at $100 per scrip while the national average paid for drug X was $90 per scrip. Thus, CMC concludes that the plan "overpaid" for drug X by $1,000. So, CMC then takes the plan's $1,060,000 actual claims cost and reduces it to $1,059,000. Now the plan has only $9,000 of excess claims eligible for the 50% reimbursement by CMC, for a reimbursement of $4,500, not $5,000. Thus the plan has been penalized another $500 for "over-paying" on Drug X and its actual net loss is $55,500.

The effect is to impose a 5 percent "overpayment penalty" on the plan for not negotiating a low enough price for drug X. Of course, the more generous CMC is in reimbursing the plans (the draft talks in places about 75 percent or 90 percent compensation for excess costs) the larger the potential "overpayment penalty" (e.g., 7.5%, 9%). Considering that this is an example of just one of hundreds of drugs the plan covers, the implications become clear. CMC can further reduce, or even eliminate, the rest of the additional $4,500 it in theory owes the plan to compensate for it's higher than expected losses if it finds that the plan "overpaid" for other drugs.

This proposed process has certain programmatic consequences. First, this saves Medicare money. Second, this is a great way to discipline plans into demanding deeper discounts from manufacturers and restricting beneficiary access. Third, it drives small players to either avoid or exit the market if they don't feel that they can get discounts as deep as their bigger competitors (and it effectively makes their competition all the plans nationally, not just the ones they compete against in their chosen area). This is compounded by the fact that plans get no equivalent, offsetting reward for negotiating a below average price for other drugs.

With fewer players in the market, more areas of the country are left with only a pre-ordained "fallback" drug plan. Manufacturers have diminished incentives to offer discounts and are more likely to just charge all plans the same price. Uniform manufacturer pricing works fine for the remaining "at-risk" plans, as they just become more like cost-plus claims administrators - same as the "fallback plans". The "at-risk" plans would then no longer have a price risk, just a volume risk, and the "fallback" plans would have neither risk.

The proposed process will not harm manufacturers -- as long as they retain the freedom to set the uniform prices that they charge. Of course, since CMC needs all the price and volume data from all the plans for each and every drug that they purchase, as well as the patient-specific price and volume data for each drug consumed by one or more of their "high-cost" enrollees, it will not take long before CMC aggregates the data into a list of how much Medicare spends in total on each specific drug. That will then be followed by the inevitable hearings targeting the high cost/high volume drugs that are costing Medicare the most money, which will in turn produce the inevitable "cost containment" (price and access control) legislation.

Part IV - The Creation of Fallback Plans

Section 1860D-13: The Creation of FallBack Drug Plans. In any "service area" where there are not at least two plans with bids acceptable to CMC, then CMC will first try to induce more plans to bid by reducing the risk borne by plans in that region by having Medicare pay a greater share of the costs above the risk corridor thresholds and/or a larger reinsurance percentage (the standard share is 80 percent for the excess claims of high risk individuals.) (1860D-13) However, CMC would not be allowed to offer "full underwriting of financial risk for any entity and could not provide for the underwriting of any financial risk for a public entity" (1860D-13)

Analysis: Section 1860D-Definitions allow a state pharmacy assistance program to apply to be a plan. Presumably, this therefore means that CMC could not assume the risk for such plans and thus, by definition, they could not be "fallback" plans. For the other plans, given that CMC is already bearing the majority of the risk in areas where there is competition, it is hard to see how letting CMC pick up more of the risk (between 80% and 99%) would induce more plans to participate.

Section 1860D-13; Medicare Risk Assumption. If CMC still cannot get at least two plans, then it will negotiate a contract with an entity to be the "fallback" plan and provide the standard coverage on a straight cost-plus basis, with Medicare bearing all of the risk. There can be only one such "fallback" plan per service area. (1860D-13)

In cases where there is only one risk-bearing plan plus the "fallback" plan, beneficiaries who did not elect a choice would be assigned to the risk-bearing plan and not to the "fallback" plan. (1860D-13)

Analysis: This levels the field somewhat since the risk-bearing plan would have an enrollment advantage to offset the disadvantage that it bears some risk while the "fallback" bears no risk. Also, "Entities that have submitted bids to be a qualified risk-bearing entity may not submit a bid to be a fallback plan." (1860D-13)

The likely effect of this proposed " fallback" process is that the PBMs will be the "fallback" plan administrators and/or subcontractors to risk-bearing plans, but will see no advantage in becoming risk-bearing entities themselves. They are not risk-bearing entities under their current business models for the existing non-elderly population, and nothing in this Senate legislative draft would give them a strong enough incentive to take on the added burdens of being risk-bearing.

For the "risk-bearing" plans, Medicare would be assuming roughly +/- 80% of the price/volume risk for the benefits they cover. For the "fallback" plans Medicare bears all the price and volume risk with the PBMs acting as Medicare intermediaries (e.g., cost-plus administrators) with the added twist that they have the power to negotiate prices and restrict access. It is hard to imagine that it will take very long before this flexibility for the PBMs is replaced with uniform price schedules and coverage rules, since as long as the "fallback" PBMs retain the ability to negotiate prices and limit access through formularies, there will be geographic variations among them in both drug prices and patient access to drugs.

Part V - Beneficiary payments and subsidies.

Section 1860D-17: The Drug Payment Process. For each plan, CMC compares the plan's monthly premium for the "standard" or "qualified" coverage (which excludes the portion of the premium that is attributable to additional coverage above the standard level -- e.g., lower deductibles and/or co-pays), with the national monthly weighted average premium. (1860D-17) Then:

1. "If the plan's monthly approved premium was less than the national average the beneficiary would pay: 1) 25/70 expressed as a percentage of the monthly national average, minus, 2) the difference between the national average and the plan's premium." (1860D-17)
2. "If the plan's monthly premium was greater than the national average, the beneficiary would pay: 1) 25/70 expressed as a percentage of the monthly national average, plus 2) the difference between the national average and the plan's premium." (1860D-17)

Analysis: Basically, the beneficiary pays 35.7 percent of the national average premium for the standard coverage, plus or minus the difference between the national average premium and the premium for the "standard coverage" portion of the chosen plan.[2]

Section 1860D-18: The Beneficiary Premium Collection. The beneficiary's share is collected though Social Security withholding the same as the Part B premium. (1860D-18) Medicaid dual eligibles would continue to get their drug coverage through Medicaid. "Persons meeting the definition of QMB, SLMB, or QI-1, and not eligible for Medicaid medical and drug benefits, as well as other persons below 160% of the federal poverty level, would receive their drug benefits through Part D. They would receive assistance for the Part D premium and cost-sharing charges." (1860D-19) Subsidies for these beneficiaries take the form of zeroing-out the deductible, scaling back the cost sharing, paying all of the premium for beneficiaries with incomes below 135 percent of poverty and charging sliding scale premiums up to 160 percent of poverty, at which point the beneficiary is responsible for paying their full share of the premium. The plans would be reimbursed by CMC for the difference attributable to the lower cost sharing for these beneficiaries. (1860D-19)

Analysis: Nowhere does the Senate draft outline explain how plans that provide coverage that is more generous than the "standard" coverage collect the additional premium for that additional coverage from the beneficiary. Presumably, the plans will bill beneficiaries directly, since there is no provision for Social Security withholding. Not automating this part of the premium collection for the plans is a disincentive for them to provide more generous coverage. In fact, nowhere in the draft does it actually say that plans either will or will not be able to charge beneficiaries additional premiums for coverage above the "standard coverage."

Part V - Employer retiree plans

Section 1860D-21: Payment to Employer Plans for Drug Coverage. The CMC would pay subsidies to qualified employer retiree plans for each beneficiary who is eligible for Part D, but is instead enrolled in the retiree plan. For the retiree plan to be "qualified" it would have to offer at least the "standard coverage" or actuarially equivalent coverage. "The amount of the payment would equal 45/70 expressed as a percentage of the monthly national average premium for the year, as adjusted by risk adjusters." (1860D-21) CMC would also compensate retiree plans with reinsurance payments for individual high-cost beneficiaries, the same as it would for the Part D plans and the Medicare Advantage plans, with the same "overpayment" recapture mechanism. (1860D-20)

Analysis: This provision means that employer retiree plans would be paid a subsidy equal to 64.3 percent of the national average premium for "standard coverage," after adjusting for geographic and actuarial risk differences.[3] To obtain additional, "reinsurance" payments for their high-cost enrollees, these private employer plans would have to submit to Medicare data on the prices they paid for all of the drugs they purchase for their retirees, as well as patient-specific data on the prices and quantities of individual drugs consumed by the "high-cost" enrollees for which they are claiming "reinsurance payments."

TITLE II- THE MEDICARE ADVANTAGE PROGRAM

Section 201: The Establishment of the Medicare Advantage System. It would replace Medicare+Choice. It would include private fee-for-service, PPO plans, PSO, medical savings accounts (MSAs) or a regional PPO. The statutory requirements for the plans would remain largely the same, with "modifications" to reflect the new drug benefit.

Analysis: It appears that the statutory language that now governs the Medicare+Choice plans would carry over into the Medicare Advantage program. It is unclear why the drafters of the Senate bill want to retain residual language of that statutory framework. The problem, not evident from the text, is that the statutory provisions of the Medicare+Choice program were at the heart of many of the well-documented regulatory difficulties, beyond the administrative payment problems, encountered by private health plans.[4] Whether the residual Medicare+ Choice statutory language will continue to contribute to private plan problems, or whether the Senate language will alleviate them, remains unclear.

The Senate language, coupled with other provisions in the draft outline, raises some urgent practical questions. For example, medical savings accounts are envisioned as participating in the new Medicare Advantage program. But, as every student of health policy knows, MSAs are currently subjected to various federal statutory and regulatory restrictions deliberately designed to retard their growth in the market. Would the Senate bill language lift those restrictions for retirees? It is not clear from the text.

Moreover, with regard to the MSA option, in particular, it is not clear that active workers would be able to bring their own MSA plans with them into retirement under the Medicare Advantage program, or whether they would have to drop those plans and pick new MSA plans that qualified for participation under this language. Moreover, it is unclear whether retiring employees could bring plans with Health Reimbursement Accounts (HRAs) or other health account options into retirement with them and qualify under the Medicare Advantage program. In the future, these plans are certain to garner an ever-larger share of the non-elderly commercial market. It is not at all clear from the Senate text that these would qualify. If they do not, the provision is incompatible with Medicare reform based on consumer choice and competition.

A far better idea would be to start over and re-develop the Medicare Advantage program, using the statutory language of Chapter 89, Title V of the United States Code: the language that authorizes the Federal Employees Health Benefits Program (FEHBP). The Senate Finance Committee clearly decided not to do that, though proponents of the Senate bill make favorable references to the federal employees model as the basis for their support of the legislation.

Moreover, to guarantee an open system, it would be appropriate to include language that provides not only for PPOs and MSAs, or HMOs or private fee-for-service plans-which may be overtaken by time and progress in the delivery of health care-but also to include the broadest possible language that would include "other private plans or options or health care delivery programs." Senate bill drafters do not, and cannot, know what the future may bring; and it is imprudent to lock health care models in statutory concrete, as they may quickly be overtaken by rapid changes in the broader health care economy. Such rigidity in Medicare's original benefit design is precisely the reason that prescription drug coverage and the need for Medicare reform are issues today.

Section 201: The Provision Of Information. The Secretary of HHS would be required to disseminate nine categories of information about the plans, ranging from benefits and premiums to drug coverage.

Analysis: The provision of a clear, solid comparative plan and coverage information in plain English (routinely the case in FEHBP, and routinely not the case in Medicare) is essential to an effective system based on consumer choice and market competition.

Section 202: Benefit Requirements. Medicare Advantage (MA) plans would be required to cover all existing Medicare benefits, except hospice coverage, plus drug coverage under the terms of Part D, catastrophic and required enhanced benefits. These would also include disease management, chronic care, and preventive services. The Secretary of HHS could exclude a plan that is "believed to attract a healthier population." Moreover, the Secretary could not approve "any enhanced medical benefit" that provided for any drug coverage other than that provided for under Part D. The quality assurance provision of current law would remain in force for MA plans.

Analysis: Comprehensive standardization of the benefits packages has been a long-term objective of those who favor government control over the American health care system. If the government controls the benefits, and the government then controls the financing, there is nothing left of anything resembling a private sector market based on consumer choice and competition. The object of serious Medicare reform should be to expand consumer choice and competition in the program, thus expanding the opportunities for individuals to secure high quality medical services available in the private sector. Medicare legislation should not become a vehicle for expanding Medicare's regulatory control over private sector plans or inhibiting the personal freedom of retirees to secure what options they think best for themselves.

This is a highly prescriptive and comprehensive benefits package; it is a direct statutory limitation on the variety of plan offerings in the program. Medicare fee-for-service covers specific medical services, treatments, and procedures. The Senate language does not even appear to provide for an actuarial equivalence for competing plans; so there is little flexibility allowed in this language for benefit design among health plans.

The provision that enables the Secretary, or the Administrator of the CMC, to exclude a plan that is "believed to attract a healthier population" is particularly troubling. The Senate draft includes MSAs, but the government officials may believe that MSAs attract a healthier population, or contribute to adverse selection, and thus exclude them. This could also apply to other new health care delivery options as well.

The proposed Secretarial limitation on enhanced medical benefits and drugs, other than those specified, is also incompatible with a new system alleged to be based on consumer choice and free market competition. If a person wished to buy a lower cost drug package, or a health plan with a leaner benefits package, there should be no statutory obstacle to them doing so. In an open, flexible market, the benefits and combinations of benefits should be the choice of beneficiaries, not government officials.

Needless to say, this provision is not similar to the statutory language of FEHBP, where there is no comprehensive standardization of benefits or services and health plans of all types can offer a variety of benefit packages, and different levels of benefits, as long as they offer the statutorily required benefit categories such as hospitalization and physicians services.

Section 202: Information requirement from plans. This would include out-of-pocket costs, stop loss, premiums and enhanced benefits.

Analysis: This provision is compatible with a Medicare reform based on consumer choice and competition.

Section 203: Government Payments to Health Plans. The new Medicare Advantage payment process is quite complicated. The payment to plans under the new system would be based on Medicare payment to plans under Medicare+Choice and the payment for Medicare benefits and services under the Medicare fee for service system. This is a crucial policy decision in the Senate bill.

Under current law, Medicare+Choice, plans in a payment area are get "an administered payment" for each enrollee, which is the highest of either a specified minimum payment, a blend of the local payment rate and the national rate, or a minimum increase over the previous year's rate. (The minimum increase is 2 percent.) The Medicare+Choice payment rates are risk adjusted to reflect variations in cost among enrollees in Medicare+Choice programs and further adjusted to meet certain budget requirements. In the case of Medicare+Choice payment, the Medicare reimbursement to private plans, which has been out of sync with real changes in the health insurance markets, has been one of the reasons why such plans have been dropping out of the Medicare+Choice program.

In the case of Medicare fee for service, hospital benefits are reimbursed according to a Prospective Payment System (PPS) for services categorized under "diagnostic related groups"; physicians' services are reimbursed according to the Resource Based Relative Value Scale (RBRVS), which is a complex formula for physician payment based on a social science measurement of the "value" of different physicians' services, plus practice expenses and other resource costs. Physicians' payments are capped (price-controlled), and updated according to a government formula. Medicare physician reimbursement has been a perennially controversial, for it is a factor discouraging physicians and specialists from seeing new Medicare patients.

Under the new Medicare payment system, it appears from the Senate language that the government would make three different monthly payments to health plans for three basic sets of Medicare benefits: for Medicare hospitalization benefits under Part A; for physicians services under Medicare Part B; and for the new drug benefits, based on the terms and conditions of the new Medicare Part D. As noted, private plans would be required under the Senate language to offer all benefits and services under Part A and B as well as the new drug benefits.

According to the draft outline: "Each year the Secretary would calculate a benchmark amount for each MA payment area for each month with respect to coverage of benefits available under Medicare FFS. For plans participating on a county basis, the benchmark would be the greater of 1/12 of the annual M+C capitation rate for the payment area for the year or the local fee for service rate. The local fee for service rate would be defined as the amount of payment for a month in a MA payment are for benefits, as well as associated claims processing costs, for an individual who elects to receive benefits under the Medicare FFS [fee-for-service] program and is not enrolled in an MA plan. In calculating the local fee for service rate, adjustments would be made to remove the costs for indirect medical and direct graduate medical education."

In 2005, the Secretary would announce the benchmark amounts for each Medicare Advantage "area" and the factors to be included in the new "comprehensive risk adjustment methodology" to be applied to payments to private plans.

In 2006, the payment would be based on bids of competing plans. The government would calculate the amount based on the weighted average of the benchmark amounts for benefits in the Medicare FFS plan. The benchmark amount would be adjusted for risk, the risk adjusters for prescription drug coverage, and health and other demographic features.

In determining payments to each plan, the Secretary would determine the difference between the weighted average in the area and the bids of each plan. If a plan bid equals or exceeded the weighted average, the plans would get the benchmark amount. If a plan bids below the weighted area benchmark, the plan would get the benchmark amount, minus 25 percent of the difference between the bid and the benchmark amount.

Analysis: The benchmark for payment private plans is to be based on the weighted average of the Medicare FFS benefits in an area. FFS benefits and services are price-controlled, and subject to Medicare complex fee schedules and payment caps. They are not market prices. This could pose a problem: it could discourage the participation of private plans. The Senate bill language could thus replicate the failure of administrative payment that has undermined the Medicare+Choice program.

Payment to private plans in the FEHBP is very different. Under the FEHBP statute, the government pays 72 percent of the average premium of participating plans (weighted by the number of enrollees) in the program. The government payment is capped, according to a formula, at a dollar amount for family and single coverage, and the government contribution is limited to no more than 75 percent of the premium cost of any particular plan. While there are clearly deficiencies in the FEHBP payment system, (for example, the current 75 percent cap means that no enrollee will ever be able to pocket the entire savings for picking a less expensive plan), the value of the FEHBP payment to plans rests in the fact that it is a payment based on real market conditions, an inherently attractive feature of the program.

An even better policy is embodied in the 1980 legislative proposal offered by Representative Richard Gephardt (D-MO): The National Health Reform Act of 1980. Rep. Gephardt proposed comprehensive Medicare reform based on a competitive system of private health plans. For Medicare beneficiaries who chose private plan options, they would have gotten a government contribution to the plan in an amount equal to the average cost of plans purchased by the Medicare beneficiaries. While the private plans would have been required to provide benefits greater in value than the traditional Medicare program, beneficiaries would have been able to choose from among a wide variety of premium options. Under the original Gephardt proposal, if a Medicare beneficiary chose a plan whose premium was less than the government's contribution, they would have been able to keep the difference as a tax refund.

In the Senate bill, there is a proposal to establish a comprehensive risk adjustment mechanism. In the FEHBP, of course, there is no risk adjustment mechanism at all -- a weakness in the current program. Even so the program, for structural reasons and reasons related to the contribution system, is not burdened by serious or destabilizing adverse selection.

Nonetheless, instead of trying to create a risk-adjustment mechanism to deal with adverse selection among plans, the Senate bill drafters might consider the establishment of a mandatory reinsurance pool, where plans cede risks associated with particularly high-cost enrollees, pay a premium into the pool and get an offset every year if they incur enrollments with higher than expected risks. This might be preferable than trying to adjustment payments up front.

In any case, if the payment is not based on real market forces, the danger is that it will be insufficient to attract significant plan participation.

Section 204: Information Required from Plans. The Senate bill provides that plans must give HHS the intent to cover a service area, the type of plan, information on coordinated care, enrollment capacity, health status of enrolled individuals, and "other information" required by the Secretary.

Analysis: This is a significant amount of required information. As a point of comparison, there is no similar statutory requirement in the FEHBP, though health plans are required by OPM to keep records of information.

Section 204 Benefit Controls. If the plan bid were lower than the benchmark, the secretary would require the plan to provide additional benefits, or lower the deductible or decrease the maximum on out-of-pocket expenses. However, plans would not be allowed to offer additional benefits for the coverage of a prescription drug other than that provided under Medicare Part D. If the plan bid was higher than the benchmark, the plan could charge a beneficiary premium.

Analysis: This is simply government control of the benefit levels and financing offered by private plans. Plans should not be limited in what they can add, in terms of drug benefits, or other kinds of legal medical services, and consumers should not be forbidden from buying such benefits and services with their own money. This is incompatible with Medicare reform based on consumer choice and free market competition.

Section 205: Special Drug Rules. Plans would be required to offer drug coverage that met coverage requirements under Medicare Part D. A plan could offer more generous coverage if it also offered the basic coverage in the same area.

Analysis: This is a government standardization of prescription drug coverage in private health plans, and it is incompatible with Medicare reform based on consumer choice and competition.

Section 206: Special Rules for Employer Sponsored Plans. Employers can sponsor a MA plan or pay premiums for retirees who enroll in an MA plan. The plans must meet the standardized benefits requirements of the MA system and the Secretary for HHS may waive rules that hinder union or employers from offering MA plans.

Analysis: The idea of enlisting employers and unions and their health plans in Medicare reform has been long championed by Heritage analysts and others. If a person is happy with their health plan they should be able simply to take that plan into retirement with them as their primary coverage, and get a premium support or government payment for to offset its cost. The comprehensive benefit standardization in the Senate bill basically undermines this option, and is therefore incompatible with Medicare reform based on consumer choice. The proposed Secretarial waiver to allow union or employer plans to participate is only necessary only because the proposed benefit standardization is unnecessarily restrictive. 

Section 207: Administration of Medicare Advantage System. The Medicare+Choice Plans created under Medicare Part C and the new Medicare Advantage Plans are to be administered by an Administrator of the Center for Medicare Choices within HHS. This ends the administration of CMS over private health plans. The new agency head could make determination that a plan had failed to meet its contractual obligation.

Analysis: This is compatible with the majority proposal of the National Bipartisan Commission on The Future of Medicare (the Breaux-Thomas Commission) and others to establish a separate agency administering a consumer-based system. The proposal is to leave CMS in charge of the administration of the traditional Medicare program.

Section 208: Conforming Amendments. The language says that a Medicare plan would "not be allowed to charge" a consumer any amount in excess of the Medicare Advantage monthly beneficiary obligation for "qualified prescription drug coverage," or provide coverage that is not "qualified prescription drug coverage," and offer prescription drug coverage but not make the standardized drug coverage available, or provide coverage "for drugs other than that relating to prescription drugs covered under Part D as an enhanced or additional benefit." Section 209 makes the effective date of this provision January 1, 2006.

Analysis: This provision would have the government specify drug benefits levels in a system of competing private health plans. This is incompatible with a Medicare reform based on consumer choice and market competition. Health plans should have the freedom and ability to devise flexible drug coverage options that meet the needs of their customers.

Section 211: The Establishment of the Preferred Provider Option. Beginning in January 2006, the authors of the Senate bill would create a new system of PPOs in ten regions of the country, which would have a network of providers that would contract for services under existing Medicare Parts A and B. The regions would be charted in such a way that states would be left whole and entire. The PPO would serve the entire region. The Secretary (or the CMC Administrator) could exclude PPOs that are "believed to attract a population that is healthier than the average population of the region serviced by the plan."

In 2006 and 2007, PPOs would not be "initially responsible" for the risk of offering medical benefits. The language sets forth a formula for limiting the risks of PPOs, though PPO's would be at full risk for all "enhanced medical benefits."

Beginning in 2006, the government would calculate a benchmark payment for each region of the country, "equal to the average of each benchmark for each MA payment area within the region," weighted annually by the number of beneficiaries in the payment area. The government would adjust these payment rates by the "comprehensive risk adjustment factor" and the spending variation within the region.

Then the plans would submit bids to the Secretary of HHS (actually, the CMC Administrator), with assumptions about the "number of enrollees." The language of the proposal then details the steps the Secretary makes in arriving at payment for PPOs: "The Secretary would adjust each plan bid based on the plans' assumptions about enrollment. The Secretary would calculate a regional benchmark amount for each plan equal to the regional benchmark adjusted for the number of enrollees assumed in the plan bid. The Secretary would determine the difference between each adjusted plan bid and the plan's regional benchmark amount to determine the payment amount, additional of benefits required, and the MA (Medicare Advantage) monthly basic beneficiary premium."

Under the Senate bill, for any plan bid that equals or exceeds the benchmark, the plan would get the plan benchmark amount. For any plan below the plan benchmark amount, the plan would get the benchmark amount minus 25 percent of the difference between the plan bid and the plan benchmark.

The Senate bill the provides that, "The Secretary shall limit the number of plans in a region to the three lowest cost credible plans that meet or exceed the quality or minimum standards."

Analysis: Not only is this a complicated payment system, but also the deliberate restriction of PPO choice to the three cheapest plans is incompatible with Medicare reform based on consumer choice and competition.

The Senate bill's creation of a government-sponsored oligopoly of regionally based PPO plans is short sighted. In the face of a rising demand for medical services among a rapidly aging population, Medicare reform language should encourage diversity and an enlargement of options.

If such plans meet basic requirements, or "minimal reasonable requirements" (as specified, for example, in the FEHBP statute), the government would not pick "winners and losers"; consumers would pick winners and losers. In a normal competitive market, there is free entry as well as free exit of plans, and consumers can pick and choose the kinds of plans and options they want, whether they are lower cost plans or higher cost plans. This obviously is not the case under this language. Needless to say, there is no similar PPO restriction in the FEHBP. Furthermore, all plans participating in the FEHBP assume the risk, not the taxpayers.

Section 221, 222 and 223: Managed Care Reform. The provisions would extend the life of certain "reasonable cost reimbursement" contracts (for managed care plans until 2009); authorize the secretary to report and regulate Medicare+Choice plans for "special needs" beneficiaries; and extend limitations on balanced billing to providers serving certain Medicare patients.

Analysis: The provisions largely retain or extend existing authorities under the Medicare+ Choice program.

TITLE III- THE CENTER FOR MEDICARE CHOICES

Section 301: The Establishment of a Center for Medicare Choices. The language of the bill provides for the establishment of the Center within HHS to administer the new Medicare Parts C and D. The Center would be governed by an Administrator, appointed by the President and confirmed by the Senate, for a period of five years. The draft outline also provides for an Office of Beneficiary Assistance within the CMC, and an Ombudsman within the CMC to handle beneficiary grievances, requests for information, and enrollment related problems. The provision sets up a Medicare Competitive Policy Advisory Board within CMC to advise, consult with and make recommendations to the Administrator regarding the "administration and payment policies" of parts C and D.

The Administrator would be authorized to issue "such rules and regulations as the Administrator determined necessary and appropriate to carry out the functions of the CMC, subject to the Administrative Procedures Act."

The duties of the Administrator include the requirement to "negotiate, enter into and enforce contracts with Medicare Advantage plans ands with eligible entities for Medicare prescription drug plans. The Administrator would be required to carry out any duty provided for under part C or D of Medicare including demonstration programs under Part C or D."

The language of the draft further specifies that, "The Administrator of the agency, to the extent possible, would not be able to interfere in any way with negotiations between eligible entities, Medicare Advantage organizations, hospitals, physicians or other entities or individuals furnishing items and services under this title (including contractors for such items and services), and drug manufacturers, wholesalers, or other suppliers of covered drugs."

Analysis: It would appear that the Administrator would fulfill a role broadly similar to that of the Director of the Office of Personnel Management in the administration of the FEHBP, in which the OPM Director exercises broad contract authority in the annual negotiation with competing health plans in that program.

There are, however, some crucial differences in this Senate Finance Committee language and the statutory language that governs the FEHBP in the regulations of health plans. In the Senate language, the Administrator is authorized to issue such regulations as the Administrator deems necessary and appropriate to fulfill the responsibilities under Medicare Part C and D.

In the FEHBP, OPM, "may prescribe regulations necessary to carry out this chapter" (Section 8913a of Chapter 89 of Title V), but the chapter focuses on a few items, such as consumer protection, non-discrimination, and fiscal solvency. The authority also extends to regulations governing the enrollment of eligible beneficiaries, the beginning and ending dates of coverage and the continuation of coverage (Section 8913b) and Section 8913c). Altogether, there are just 18 sections of Chapter 89, Title V, and they range from OPM's contracting authority, to provision of information to individuals eligible to enroll and the management of the Employees Health Benefits Fund.

In the FEHBP, OPM is authorized under Section 8902 of Title V of the US Code to "prescribe reasonable minimum standards for health benefits plans… and for carriers offering the plans." The minimum reasonable standards apply to contracting with different types of plans, and providing for different levels of benefits. (Sections 8903 and 8903a). So, at least in terms of dealing with health plans, the CMC Administrator, to all appearances, has a broader regulatory reach than OPM.

The Senate language appears to put a barrier to the Administrator's interference with contracts between plans and with doctors and hospitals and other entities, but then adds the foreboding caveat: To the extent possible. But, the possibilities of the Administrator's power are up to the Administrator, and thus only limited by the Administrator's possible enthusiasm to micro-manage private plans.

In a competitive system, like the FEHBP, for example, the government does not intrude into private contractual relations between doctors and hospitals and health plans or other entities. In the case of wrongdoing, criminal behavior or cases of medical malpractice OPM is authorized to bar physicians from the program. (Section 8902a, Chapter 89, Title V).

Moreover, in a competitive system, like the FEHBP, there is no centralized imposition of fee schedules (like the Medicare DRGs or the RBRVS), premium caps, price controls, formularies for drugs, or any imposition of physician or medical practice guidelines on doctors or other medical professionals. One of the benefits of a consumer-driven system is to enable patients, if they wish to, to avoid that sort of intervention. This language, however, does not appear to preclude such interventions.