The Senate Finance Committee -
Mr. Chairman, my name is Stuart Butler. I am Vice President for
Domestic and Economic Policy Studies at The Heritage Foundation.
The views I express in this testimony are my own, and should not be
construed as representing any official position of The Heritage
I am pleased to be invited to testify on the issue of Medicare
reform. I believe the majority of members of the recent bipartisan
commission laid out a good framework for modernizing and
strengthening the program. As the commission recognized, reform
involves not only addressing the financing of Medicare, but also
critical governance issues. Today I would like to focus primarily
on these governance issues because many of the pressing concerns
facing Congress, such as how to provide a drug benefit, are in fact
symptoms of flaws in the organizational design of Medicare.
Let me summarize the main points I make in the body of my
- The Medicare Commission's premium support proposal would be
the best way of guaranteeing a Medicare entitlement while
introducing incentives for beneficiaries to make cost-conscious
Premium support can be:
Indexed to adjust for changes in
Adjusted by income.
Adjusted for high-cost medical
Designed as a base amount plus a
percentage of premium (a version of the Federal Employees Health
Benefits Program [FEHBP] formula).
- Congress should create a Benefits
Board to depoliticize changes in Medicare benefits and to
facilitate the gradual evolution of Medicare benefits.
Board proposals should be subject to an
up-or-down vote without amendment, much like the procedure used in
the Base Closing Commission.
Only broad benefits categories should
be set by Congress (like the FEHBP).
Medicare should be reconfigured as a
leaner core set of benefits and a range of supplementary
The Benefits Board approach should be
used immediately to determine how to create a drug benefit in the
fee-for-service program for a given budget.
- Congress should create a Medicare
Board to manage the market for competing plans, taking this
role a way from the Health Care Financing Administration (HCFA).
The Board should be allowed to negotiate services and prices with
HCFA cannot and should not combine the
role of managing a market of competing plans with the role of
developing and marketing the fee-for-service plan -- one of the
HCFA evidently cannot carry out its
consumer information functions. It is significant that while HCFA
spent $95 million in a futile attempt to produce a consumers'
handbook for Medicare, Washington Consumers Checkbook
completed the same task for the FEHBP, with complicated differences
in benefits to explain, through the efforts of just one analyst
working for two months with clerical assistance.
The Medicare Board, separate from HCFA,
would carry out functions similar to those of the Office of
Personnel Management (OPM) within the FEHBP.
Using the OPM/FEHBP model, the Board
should negotiate benefits, service areas, and prices with plans,
instead of the current approach of regulation and price
- Congress should empower the
traditional fee-for-service program to compete.
- Give HCFA greater freedom to introduce innovation into the
fee-for-service program. Give the agency the power to create the
equivalent of charter schools in Medicare.
REFORMING THE MEDICARE PROGRAM
Congress must move swiftly to reform Medicare before the aging
Baby Boom generation makes reform increasingly difficult. Several
steps should be incorporated into a reform measure.
- The Medicare Commission's premium support proposal would be
the most effective way of combining the objectives of (a)
guaranteeing seniors an entitlement to an affordable core set of
benefits, while (b) giving seniors the incentive to seek the most
cost-effective way of obtaining Medicare services.
For some time, the Medicare debate has been portrayed as a clash
between two irreconcilable approaches to providing financial
support to the elderly to pay for health care. One approach --
known as "defined benefits" -- guarantees those eligible for the
program a comprehensive set of specific benefits without regard to
the cost to Medicare of those services. While this approach
protects beneficiaries from future rises in the costs of those
service, the approach has been criticized as placing a huge
financial risk onto the shoulders of taxpayers. The other approach
-- known as "defined contribution" -- would provide seniors with a
specific amount of financial help to pay for benefits. While this
approach limits the risk for taxpayers and creates incentives for
seniors to seek cost-effective plans, it has been criticized as
shifting all the future financial risk to beneficiaries.
A sensible compromise between these two approaches is implicit
in the "premium support" approach favored by the majority of
members of the Medicare Commission. Under this arrangement,
Medicare beneficiaries would receive financial assistance in the
form of a blend of the two approaches. While several variants are
possible, under a premium support system seniors could receive a
contribution to the costs of a plan, but this contribution could be
adjusted each year -- or indexed -- to cover the market price of
plans providing a core set of benefits. In that way the elderly
would continue to have an entitlement and know that the costs of
standard coverage would be assured, but the premium support
approach means they would also have a strong incentive to choose a
Congress should recognize that the premium support approach does
not mean that the elderly and disabled are simply given an
"arbitrary" voucher and are at risk for unbudgeted changes in the
cost of their health coverage. In fact, the basic idea of a premium
support can be modified in several ways to address variety of
policy goals and to protect enrollees. For example:
The base amount of premium support
could be adjusted by income, so the low-income senior would have a
larger amount of assistance.
The base amount could be adjusted
(i.e., indexed) to account for the higher costs of certain medical
A variant would be to combine an
indexed, fixed amount of support with a percentage of the cost of a
chosen plan above the standard amount up to a certain dollar limit.
In this way, seniors who felt it necessary to choose more expensive
plans, because of their medical condition or personal preference,
would pay only part of the extra cost. Such a percentage support
system is used in the FEHBP.
While these varied forms of the premium support approach would
address the concerns of lawmakers who prefer a defined benefits
system, covering only an indexed base premium, or a percentage of a
higher premium, also would achieve in large part the incentives of
a defined contribution. Just as federal workers in the FEHBP well
know, the premium support approach would create incentives for
beneficiaries to seek the best value for money in a plan, because
they would gain financially by choosing a more economical plan.
- To enable the benefits package to be
revised and improved steadily over time, the current politicized
process for changing benefits should be replaced with a Benefits
Board and other steps.
The current discussion about the need to add an outpatient drug
benefit to Medicare simply underscores two related failings in the
design of the program. The first is that ever since its inception,
the Medicare benefits package has slipped further and further
behind what would be acceptable in typical plans for the working
population. The second is that the program will be constantly out
of date so long as it takes an act of Congress to accomplish
benefits changes in Medicare that in the private sector would be
made in a few routine management meetings.
When Medicare was created in 1965, its benefit package was based
on the prevailing Blue Cross/Blue Shield package for working
Americans in large firms. As such, it was "state-of-the-art"
coverage. But since then, the benefits package has gradually
slipped further behind the benefits routinely available to working
Americans. For example, Medicare provides no outpatient drug
benefit. Yet it would be virtually unthinkable for a plan to be
offered to workers in large corporations today that did not have at
least some coverage for outpatient pharmaceuticals and protection
against catastrophic medical costs.
The main reason that the benefits package is out-of-date despite
general acceptance -- it needs to include such items as a drug
benefit -- is that all major changes in benefits require an act of
Congress. Consequently, discussions about changing benefits (and
especially introducing new benefits by reducing coverage for less
important ones) are necessarily entangled in the political process.
Providers included fight hard and usually effectively to block
attempts to scale back outdated coverage for their specialty.
Meanwhile, talk of upgrading the Medicare benefits package
unleashes an intense lobbying battle among other specialties
seeking to be included in Medicare benefits. Invariably, the final
result depends as much -- if not more -- on shrewd lobbying than on
good medical practice. The understandable reluctance of most
lawmakers to subject themselves to this pressure slows down the
process of modernizing benefits.
Just as problematic is HCFA's complex administrative process of
modifying benefits and determining whether certain medical
treatments or procedures are to be covered under the Medicare
benefits package and under what conditions or circumstances they
are to be reimbursed. This Byzantine process is marked by intense
pleading by medical specialty societies, occasionally accompanied
by congressional intervention.
A long-term reform of Medicare must end the structurally
inefficient and politicized system of changing or modifying
benefits over time. The best way to do this involves three
Set only broad benefit categories in
Congress.. Rather than set specific benefits in legislation,
Congress could confine itself to describing the broad categories of
benefits that private plans competing in Medicare should provide
(such as emergency care, drug benefits, etc.). This is the approach
Congress has taken with the FEHBP.
Create a Medicare Benefits
Board. Instead of Congress or the Administration's specifying
detailed benefits, Congress could create a Benefits Board to
propose specific incremental changes in the core benefits for
Medicare. Such an independent board would have members selected for
specific terms by the Administration and Congress. The
recommendations of the board package would be subject to an
up-or-down vote by Congress. This would reduce political pressures
on benefit decisions and take lawmakers out of the process of
making detailed medical decisions; yet it would give Congress the
final say in any benefits changes. Essentially, the practical logic
for establishing a board to function in this way is the same as the
logic for creating the Base Closing Commission in the 1980s.
Establish Medicare as a combination
of core and optional benefits. The broad categories for core
benefits determined by Congress or a board could be confined to the
"must-have" basic benefits expected of Medicare rather than the
comprehensive benefits most seniors would actually obtain. In other
words, the Medicare coverage for a senior (that is, someone
eligible for premium support) would consist of a base set of
benefits in every plan or in the traditional fee-for-service
coverage plus a variety of negotiated supplemental benefits
according to the needs and desires of each senior. Over time, it
could be expected that the typical supplementary coverage would
adapt to changing needs, desires, and medical practice. This
two-tier benefits package thus would allow gradual adjustments in
benefits according to the desires of individual seniors and would
not require legislation by Congress to permit changes over time.
This is essentially the process used in the FEHBP. In the FEHBP,
broad categories of coverage are required, but the specific levels
of benefits, including the kinds of medical treatments and
procedures, offered by typical plans change with the times. Plans
know they must keep up with medical developments yet remain
cost-effective if they are to be selected by beneficiaries and
thereby stay in business.
Had Medicare been able to evolve gradually, like the FEHBP,
through these ways of significantly depoliticizing changes in
benefits, Medicare no doubt today would have a modern and efficient
system of benefits, more like the FEHBP and like Medicare at its
Creating a drug benefit in the fee-for-service program.
The first task for the proposed Benefits Board should be to
determine the best way to introduce a drug benefit into the
traditional fee-for-service segment of Medicare. With a board in
place, Congress could instruct it to develop a modified benefits
package, including drug coverage, within a specified budget. To
work within the budget constraints, the board might develop a plan
to make small changes in a number of features of the benefits
package to achieve a well-balanced package that achieved Congress'
objectives. The plan would be sent to Congress for an up-or-down
vote without amendment. Should it fail to win approval, the board
would develop a modified version until agreement could be
- Remove from HCFA the function of
managing a market of competing plans and place this function under
a new Medicare Board with powers to negotiate prices and services
HCFA currently is responsible for operating the traditional
fee-for-service program. But is also responsible for establishing
and managing the market for the increasing range of plans that are
offered to seniors at a monthly premium. This combination of tasks
is inherently unsound and explains many of the problems and
shortcomings at HCFA.
Basic Conflict. It is a very basic principle of economic
organization in a market that those responsible for setting the
rules of competition, and providing consumers with information on
rival products, should have neither an interest in promoting any
particular product nor even a close relationship with one of the
competitors. That is why the Securities and Exchange Commission
maintains a wall of separation between itself and individual
companies. It is why Consumers' Reports accepts no
advertising from products it evaluates. And it is why umpires in
baseball do not own baseball teams. It is also the reason why state
and local governments (and the federal government under the A-76
program) have a different agency evaluating competitive bids for
government services from the agencies providing those services
in-house. Entangling the running of a market with the management of
any of the competing providers is a recipe for problems. It is
interesting to note that in the federal health program that
operates a market of dozens of competing plans made available to
federal workers (the FEHBP), the agency responsible for running
that market and providing information to beneficiaries (the OPM)
does not run a plan itself.
This separation is not only necessary to avoid a conflict of
interest, it is also necessary because the managerial cultures are
very different for staff engaged in these two very different
functions. Managers charged with dispassionately operating a market
must display evenhandedness and pay close attention to the
information that consumers need to make wise decisions. On the
other hand, those managers engaged in marketing a particular plan,
including a government-sponsored plan, must be highly competitive
and concerned with the long-term viability of their particular
product and the continued satisfaction of their customers. The
cultural difference is much like that separating a judge from a
The simple fact is that HCFA cannot and should not carry on both
these tasks. The main reason it cannot is that the agency has, over
the years, developed a culture and expertise that focuses on
regulating prices and services and identifying fraud and abuse. The
training and skills of the staff reflect this general function. By
contrast, HCFA has a shortage of the experience and skills needed
to establish ground rules for a competitive market, develop
businesslike relationships with competing private health plans, and
provide consumers with the information they need to get the best
value in such a market. For example, HCFA's efforts to create a
handbook of information for beneficiaries that they could actually
understand turned out to be a $95 million fiasco. Significantly,
such a handbook has been available for many years for enrollees in
the FEHBP. Besides a brief booklet from the OPM, a private
consumers' organization, Washington Consumers Checkbook,
produces a comprehensive guide, including patient rating surveys of
plans, which is assembled by one analyst working for two months and
backed-up by a few clerical staff.
It is not that HCFA staff is inherently incompetent, but that
they have little training and expertise in these functions. It is a
little like expecting experienced divorce lawyers suddenly to
become good marriage counselors. Staff members at the OPM who
operate the FEHBP, by contrast, have very different skills and
backgrounds, and the agency has a different culture -- which is why
OPM is successful at running an nationwide program with many
competing plans in each area.
But HCFA should not carry out those functions even if it had the
skills to do so, because it is extremely unwise to permit an
organization to be responsible for setting the rules of a
competitive market when it also has a direct interest in the
success of one of the competitors. So long as HCFA runs the
fee-for-service program of Medicare, it hardly can be expected to
benignly create a market in which other plans compete directly with
the traditional fee-for-service program.
Congress must, however, accept much of the blame for the
agency's problems. HCFA's current structure and statutory
obligations do not allow it to maintain a proper separation between
these functions and are a impediment to the agency's ability to
carry out either function very effectively. This stems from the
fact that HCFA historically has acted as a bill-payer and
regulator, rather than a referee in a market and a consumer
information agency. As the Institute of Medicine (IOM) notes in its
1996 analysis of the Medicare market, "In the past HCFA has made
little effort to inform Medicare enrollees of their choices
regarding health care providers, treatment options, or competing
private plans."1 And as the General
Accounting Office notes in a 1995 study, HCFA amasses vast amounts
of information but has a poor track record in providing information
to beneficiaries that is useable.
To be sure, HCFA has been taking steps to provide better
information to beneficiaries, including data on high-mortality
hospitals and better benefits information. However, this falls far
short of what is needed to enable elderly Americans to make
sensible choices when there is an increasing number of options
available. Moreover, even with the recent reorganization, the
conflicting functions of dispassionate market management and plan
operation are still hopelessly entwined.
Comparison with the OPM. It is interesting to contrast
the way in which HCFA functions as a manager of a market with the
manner in which the OPM functions within the FEHBP. According to
James Morrison, the career civil servant who ran the FEHBP during
the Reagan Administration, the contrast stems not from any inherent
deficiency of HCFA staff as civil servants, but from differences in
the structure imposed on the agencies running the two programs.
This suggests that Congress must modify the program design if it is
to achieve a change in the way HCFA functions. As Morrison explains
to me in a note (which he has permitted me to make available to the
There is a profound difference in the way the Health Care
Finance Administration (HCFA) deals with the private sector
intermediary in the Medicare program and the way in which the
Office of Personnel Management (OPM) deals with the private sector
plans in the Federal Employees Health Benefits Program (FEHBP).
This difference derives, in large measure, from the statutory
difference between the two programs.
Medicare is a highly prescribed, statutorily defined program
with benefit levels and payment rates essentially fixed in law. The
FEHBP, on the other hand, has very few statutory prescriptions.
Beyond the bare outlines of a core benefits package, specifics of
the plan's offering and its price must be negotiated between the
government and the private sector carrier. These fundamental
differences shape the values, roles, responsibilities, and indeed
the operating culture, of the administering agencies. Thus, HCFA
employs legions of regulators bent on prescribing every detail of
the Medicare program, and scores of health policy "experts" to
determine the needs of beneficiaries. OPM employs a small number of
contract specialists who can assess the price and value of a plan
offering while leaving the determination of customer needs to
individual consumers. HCFA places a premium on employees with
advanced degrees in health policy; OPM values private sector health
Create a Medicare Board. The Medicare Commission
recognized this inherent problem when a majority of its members
voted to establish a board to take over many of the marketing
functions, and the management of private plans, now undertaken by
HCFA. To establish such a board, Congress should create within the
Medicare program a body that is the functional equivalent of the
OPM within the FEHBP. The function of this body, and the focus of
the staff within it, should be to structure and operate a market of
competing plans, including the traditional fee-for-service plan,
and to provide Medicare beneficiaries with the information they
need to make the wisest choice possible.
This Medicare Commission proposal is very similar to a
recommendation of the IOM's Committee on Choice and Managed Care in
1996. In making its recommendation, the IOM committee emphasized
that HCFA currently tries to undertake two very different functions
that demand very different approaches and skills. The IOM committee
noted, among other things:
"The administration of the multiple
choice program and the management of the traditional Medicare
program involves very different mission and orientations."
"The two functions require different
types of management, staff expertise, backgrounds, and knowledge.
The committee is concerned that staff and senior managers with
extensive experience in managing various aspects of multiple choice
in the private sector be recruited and employed for this
"The functions call for different
organizational and corporate cultures, one operating a stable
traditional public indemnity insurance program and the other a
purchaser- and customer-oriented program that is required to be
responsive to a diverse group of private programs in a rapidly
changing and dynamic market place."2
The creation of a Medicare Board would permit the function of
managing a market of competing plans to be separated from the
operation of the traditional fee-for-service program as one of
those competing plans. This would accomplish the economic and
managerial objectives set out at the beginning of my testimony.
The new board could answer directly to the Secretary of Health
and Human Services (HHS), and would have similar functions to those
of the OPM within the FEHBP. Among the board's functions:
Setting standards for all plans
being offered to Medicare beneficiaries, and certifying that all
plans meet those standards. The standard setting should apply
to the traditional fee-for-service program as well as the new
choice programs created by Congress.
Negotiating with competing plans
regarding benefits and prices. Just as the OPM negotiates with
individual plans before they are offered to federal employees
during open season, so, too, should the board use Medicare's
purchasing power to push plans into providing the best options for
seniors. One of the main reasons for doing this is to ensure that
plans compete for business by offering good value rather than by
introducing dubious marketing techniques (such as artificial
boundaries for marketing areas, or benefits designed only to
attract low-risk customers). CalPERS carries out a similar function
for California state employees, as do many large corporate
purchasers of health care.
Organizing payments to chosen
plans. The board should evaluate and propose refinements of the
payment system to plans, including the traditional fee-for-service
plan, and recommend these to the Secretary of HHS and Congress.
Providing data and information to
consumers. The board would take on the function of providing
consumer and benefits information to seniors and guidance on how to
make wise choices. This function would include examining techniques
to measure quality and incorporating prudent techniques into the
information made available to beneficiaries.
In order to carry out its mission effectively, the board itself
should contain certain elements. One of these should be an Advisory
Council, mainly representing consumers but also organizations with
a general interest in creating a market for high-quality health
care. However, the board, and the Advisory Council, should receive
policy and technical advice on issues affecting the market for
Medicare plans from an outside advisory body with experience of
other health care markets. I would suggest that the Medicare
Payment Advisory Commission (MedPAC), with an expanded staff, could
play this role.
In addition, the board would need a full staff to undertake its
broad functions. Some of these staff could be recruited from among
current HCFA personnel. But for the reasons mentioned earlier, and
emphasized by the IOM committee, it would be wise to recruit some
staff from outside the Department of HHS in order to introduce new
skills and experience. Some individuals might be recruited from the
OPM, and others still from the private sector.
A Drug Benefit for Plans. In the FEHBP, there is no
statutory requirement on plans to include an outpatient drug
benefit. But the plans do include such a benefit. The benefit
simply emerged as plans came to realize they could not compete
without a drug benefit in a market where federal employees had a
wide range of choices each open season. Like most benefits
in the FEHBP, in other words, plans gradually included the benefit
to reflect prevailing customer demand. On some occasions, the OPM
actively encourages the inclusion of particular benefits by
including them in its annual call letter to plans. Not all plans
respond by proposing to include the OPM-suggested benefit; but,
typically, leading plans that seek to market themselves as the most
comprehensive available will do so. In the other cases, the OPM
actively negotiates with plans on ways they might include the
benefit, and the result is that it may be offered in vary different
ways by different plans, reflecting local conditions and market
The proposed Benefit Board could encourage the inclusion of a
drug benefit in the
Medicare private plans in the same way. It could request plans
to include outpatient drugs, and it could negotiate with plans for
ways to do this in the least costly way.
- Empower the traditional
fee-for-service program to compete
Because of the statutory basis of the fee-for-service benefits
package and the many requirements Congress places on HCFA, it is
currently very difficult for the agency to make improvements in the
fee-for-service program so that it becomes more competitive and
modern. Thus, the fee-for-service is inherently at a disadvantage
when competing with the more flexible private plans now being made
available to seniors.
The Medicare Commission discussed giving HCFA more flexibility
to enable the fee-for-service program to compete more effectively.
This makes sense -- though, for the reasons discuses earlier, only
if the agency is relieved of the power to set the rules for
If Congress were to do this, it would give HCFA the same ability
to compete as states and local governments routinely give
"in-house" public agencies when they are subject to competitive
bids from the private sector. There is no reason why public
enterprises cannot be competitive and entrepreneurial. In virtually
every state of the union, we see such innovation, from the delivery
of municipal services to the management of public education.
Congress should give HCFA the same kind of flexibility and
entrepreneurial opportunities that school districts are giving
teachers and principals to create charter schools.
Specifically, Congress should refrain from locking HCFA into a
statutory straightjacket, where its primary function is the rigid
and increasingly onerous and ineffective micro-management of the
financing and delivery of health care services for senior citizens
under fee-for-service. Instead, Congress should give HCFA greater
flexibility to run the traditional fee-for-service program in ways
that would make it an aggressive competitor to managed care plans
and other emerging private-sector health care options in the next
century. Whenever a competitive market is introduced, the
government-provided service must be given every opportunity to
redesign itself to compete effectively. This should be so in
Medicare. Thus, HCFA should be permitted to introduce innovations
into the management of traditional fee-for-service Medicare. It
should be allowed, for instance, to make extensive use of preferred
provider organizations of those physicians and hospitals giving the
best value for money. It should also be allowed to contract out the
management of the traditional program in areas where that might
Butler, Ph.D. is Vice President of Domestic and Economic
Policy Studies at The Heritage Foundation.
1. Stanley B.
Jones and Marion Ein Lewin (Edit.), Improving the Medicare
Market (Washington, D.C.: National Academy Press), p. 72.
Ibid., pp. 107-108.