Report Health Care Reform


November 13, 2003 12 min read
Senior Fellow
Robert E. Moffit is a senior fellow in The Heritage Foundation's Center for Health Policy Studies.

"Republicans are eager to win the support of Senator Edward M. Kennedy, Democrat of Massachusetts. But it is unclear whether they have made enough concessions to do so."

--Robert Pear, The New York Times, November 12, 2003


The House-Senate conference committee outline agreement this week guts any serious long-term reform of the troubled Medicare program while proposing the single largest entitlement expansion in the program's history. Instead of enacting real reform at a date certain and in time to accommodate the retirement of the massive baby-boom generation, key congressional leaders are instead proposing a limited "demonstration project" to test serious Medicare reform, confined to a few areas of the country.


Such a demonstration project will not mean the testing of reform. It will mean the killing of reform. Previous experience with federal health care demonstration projects suggests strongly that political and special-interest opposition to competition will guarantee the failure of a demonstration program.


The House and Senate majority leadership reportedly favors scrapping the House-passed provisions in the Medicare drug bill to move toward national Medicare reform in 2010, substituting instead a limited demonstration program in four metropolitan areas of the country and a geographic region, whose geographic boundaries are yet to be determined. According to a recent Associated Press report:


Officials said that (Senate Majority Leader) Frist, with the support of Speaker Dennis Hastert, offered to drop a longstanding GOP demand to have direct competition become a permanent feature of Medicare. Instead, he proposed a three-year temporary program beginning in 2008 that would take effect in one of 11 regions of the country, as well as four metropolitan areas. After three years, the administration would have the ability to extend the program for another three years. [1]


In other words: Current and future taxpayers are to be saddled with a universal drug entitlement of unknown cost as a permanent feature of the already ailing Medicare program, but a system of market-based competition would now be reduced to a temporary and uncertain phenomenon, subject to relentless political attack over the next several years.


Killing Serious Reform: The Tried and True Method

Members of Congress should be under no illusion about the record of similar Medicare "demonstration" projects enacted in previous Congresses. Previous attempts to demonstrate some form of competitive pricing in the Medicare program are well documented, and the efforts have been routinely undermined or destroyed. Nonetheless, the latest congressional leadership proposal continues a tiresome pattern of bad federal health policy that undercuts, either intentionally or by inept design, the effectiveness of serious market-based health care reforms.


Consider the experience in three cases:


  • The Medical Savings Account Demonstration Project of 1996. The language of the Health Insurance Portability and Accountability Act of 1996 (Kennedy-Kassebaum Bill) created a four-year demonstration project, setting a time limit on the market opportunities for developing and selling MSA products. The bill also imposed a cap of 750,000 policies and fixed the population eligible to firms ranging from 2 to 50 employees.

    The experience. The demonstration project was hobbled by dozens of statutory and regulatory conditions. Not surprisingly, it was less than successful. If the purpose of the project was to create a robust market for MSAs, it could not have been more poorly designed. Since the enactment of the badly designed MSA program, congressional champions of consumer choice and competition have had little chance to expand on the demonstration. Indeed, in face of intense hostility in Congress, they have been forced to concentrate on trying to undo the restrictions on the MSA demonstration.


  • Medicare+Choice Experiment of 1997. As part of the Balanced Budget Act of 1997, Congress created the so-called Medicare+Choice program.

    The experience. Although it was accompanied by free-market rhetoric of choice and competition, the Medicare+Choice program turned out to be a textbook example of political opposition and over-regulation, discouraging health plan participation and so reducing the supply of health plans and depriving seniors of promised choice.[2] Moreover, the problems associated with the administrative and congressionally imposed restrictions became a pretext for opponents of consumer choice and market-based competition to declare choice and market competition to be unworkable and undesirable.

  • The Medicare "Competitive Pricing" Demonstrations of the 1990s. In the 1990s, four "competitive pricing" demonstration projects were established in the Medicare program to test a new form of private health care plan. The demonstrations were in Baltimore, Maryland; Denver, Colorado; Phoenix, Arizona; and Kansas City, Missouri. The most significant of these were the demonstration projects created in the Balanced Budget Act (BBA) of 1997 in Phoenix and Kansas City. Under the BBA arrangements, Congress set up a Competitive Pricing Advisory Committee, comprised of private-sector experts, to oversee the creation of a system of competitive payments for the Medicare+Choice plans.

    The Experience. The aim of Medicare reformers was to create rational incentives and price competition in the program. But the plan payment system implemented in the Medicare+Choice program involved "administrative pricing." Administrative pricing means prices set by government rather than by the market. This turned out to be both inefficient and inequitable As Urban Institute analysts Len M. Nichols and Robert Reischauer observed in 2000, "In the case of M+C plans, administrative pricing has both led to excessive Medicare spending and created significant inequities for beneficiaries."[3]

    All four of these projects were successfully undermined by political opposition and economic self-interest. The policy experience has been well summarized by the editors of Health Affairs in a 2000 special section on the demonstrations:

Recent demonstrations of the concept were fraught with operational obstacles, fierce industry opposition at the national and local levels, and congressional hostility. The upshot: The demonstrations never fully materialized, which suggests that such tests may not be feasible or even desirable.[4]


Yet this successful opposition was not as ideological, nor as intense, as that currently being directed against current efforts at Medicare reform.


Key Lessons From the "Competitive Pricing" Demonstrations

Based on the previous "competitive pricing" experiments alone, health policy analysts can point to a variety of painful lessons:


  • There will be intense opposition from narrow special interests. These interests include doctors, hospital officials, health plans, and other providers who have often resisted having to compete with each other on the basis of price.[5] As Robert Reischauer and Len M. Nichols observed:

While it is common to talk about the Medicare program as health benefits for the elderly, it is also an important source of income for providers and plans. Competition and the efficiency it produces will inevitably hurt some local providers and plans.[6]


  • Congressional delegations will obstruct the demonstrations. Reflecting the strong self-interest of local providers, state and local congressional delegations often have lined up in opposition to Medicare "competitive pricing" demonstrations that threatened the status quo. Often, the delegations have been instrumental in enacting measures to block or impede their implementation. This was particularly the case with Medicare+Choice demonstration projects authorized under the Balanced Budget Act of 1997. As Nichols and Reischauer have explained:

Congress as a whole did not kill the demonstrations it approved in the BBA. Rather, the leadership on both sides of the aisle and the White House allowed a few members to kill them, for reasons that had precious little to do with long run Medicare reform policy.[7]


  • There will be destructive congressional micromanagement. Even if the Congress decides, as it did in 1997, to establish a semi-independent body to make key decisions governing the Medicare demonstration, it is unlikely that the demonstration will escape congressional micromanagement, an intervention invariably designed to make the process fail. As Bryan Dowd, a prominent health policy analyst, and his colleagues have noted, "Over the history of the Medicare program, Congress repeatedly has prevented HCFA [the agency then running Medicare] from implementing efficient purchasing practices."[8]

  • Demonstrations are not necessarily the easier road to reform. Demonstrations are often portrayed as easier to enact and put into place than national reforms. But the curious feature of a limited Medicare demonstration project, such as that currently being proposed by the House and Senate leadership, is that it often turns out to be more politically difficult to accomplish successfully than enacting major changes on a national level. Perhaps the best example of a sweeping national change is the comprehensive physician payment reform of 1989, which resulted in a complete overhaul of the complicated method for paying all physicians, in every specialty, who treat Medicare patients. Phased in nationally over five years, it changed the entire payment practice in Medicare in one step.

    This lesson applies with special force to changing the payment system to private plans through Medicare reform. As Dowd and his colleagues also note:

Paradoxically, it may be politically easier, but riskier, to implement competitive pricing in Medicare as part of national reform with no demonstration. Demonstrations single out groups of beneficiaries and treat them differently from their peers. When the changes that are being tested have a significant and direct effect on all of the major stakeholders in a site, demonstrations may be impossible. At least, based on the record to date, Congress will defer to the complaints of sites that have been singled out.[9]


Reverse the Retreat From Serious Medicare Reform

Serious reform means only one thing: the creation of the premium support financing system, modeled on the superior Federal Employees Health Benefits Program (FEHBP) as recommended by the majority of the National Bipartisan Commission on the Future of Medicare and subsequently cited as a model for choice and competition by President George W. Bush. The most significant provision in either the House or the Senate legislation in this regard is Section 241 of the House bill, a provision that would set up an FEHBP-style competitive system starting in 2010 and then phase the program in over a period of five years. The Senate bill has no such provision.


While a major improvement over the competitive features of the Senate bill, Section 241 of the House bill would not kick in until 2010, even though the first wave of the massive baby-boom generation becomes eligible for Medicare in 2011. That makes the reform timetable in the House bill an enormous political risk. It would be far wiser to give new retirees a chance to carry private plans into retirement, while creating an infrastructure of choice and competition early enough to absorb the coming demographic shock of the baby-boom population, and make the necessary adjustments well before the onset of the first wave of that generation's retirees.[10] Moreover, by setting the date so far in the future, the House provision, while laudable in itself, would still be vulnerable over the next several years to attempts to undermine it by relentless congressional opponents of any serious change in the Medicare program, particularly those who champion a single payer health care system for the United States.


A better option would be to strengthen the competitive provisions of Section 241 of the House bill, not dilute them in the form of an even more vulnerable demonstration project, by starting the process of serious reform earlier, in 2007 or 2008. The best way to do that would be to create the infrastructure of choice and competition, and deem any private or public health plan covering new retirees eligible for premium support for the primary coverage of retirees. FEHBP plans and state employee retiree plans, for example, would be deemed automatically eligible. Moreover, a new FEHBP-style system should not be burdened by operating within rigid geographical service areas or forced to comply with comprehensive benefit standardization. Both would inhibit plan participation, flexibility and, innovation.


FEHBP Superior to Medicare Program

There has already been a demonstration program of premium support. It is the Federal Employees Health Benefits Program, and it has been in operation for over 43 years. Predating Medicare itself, the FEHBP has covered millions of workers and retirees over that long period, including retirees who were never covered by Medicare. Indeed, from 1960 to 1983, federal retirees relied upon the premium support system of the FEHBP as their primary coverage; its use as supplementary coverage for federal retirees was not generally available until the enactment of amendments to the Social Security Act in 1983.


The FEHBP is superior to the Medicare program in every conceivable way. It is superior in the richness and variety of its health plans and benefits; in its flexibility in administration; in its rapid accession of new medical procedures, treatments, and technologies; and in the relatively low level of bureaucracy and regulation that governs the program. And, contrary to routinely inaccurate assertions of opponents of the FEHBP to the contrary, the FEHBP, particularly when controlling for the value of benefits, is a superior program in controlling health care costs.


Members of Congress know these facts about the FEHBP. That is why they have no excuse for retreating from a long-term reform of Medicare by enacting a demonstration program that is doomed to failure.

[1]Mark Sherman, "Congress Closer to Prescription Drug Bill," Associated Press, November 12, 2003, at 2:04 PM.

[2]For a brief assessment of the impact of the Medicare+Choice regulatory system, see Robert E. Moffit, "Regulated to Death: How Medicare's Bureaucracy Is Killing Seniors' Choices," Heritage Foundation Executive Memorandum No. 687, June 29, 2000. On the weaknesses of the Medicare+ Choice system generally, see Sandra Mahkorn, M.D., "How Not to Reform Medicare: Lessons from the Medicare+Choice Experiment," Heritage Foundation Backgrounder No. 1319, September 15, 1999.

[3]Len M. Nichols and Robert Reischauer, "Who Really Wants Price Competition in Medicare Managed Care," Health Affairs, Vol. 19, No. 5 (September/October 2000), p. 31.

[4]"Special Section: Medicare's Experience With Competitive Pricing," Health Affairs, Vol. 19, No. 4 (September/October 2000), p. 8.

[5]On this point, see Bryan Dowd, Robert Coulam, and Roger Feldman, "A Tale of Four Cities: Medicare Reform and Competitive Pricing," Health Affairs, Vol. 19, No 5 (September/October 2000), p. 24.

[6]Len M. Nichols and Robert D. Reischauer, "Who Really Wants Price Competition in Medicare Managed Care," Health Affairs, Vol. 19, No. 5 (September/October 2000), p. 43.

[7]Ibid., p. 42.

[8]Dowd et al., "A Tale of Four Cities," p. 26. Dowd and his colleagues are even skeptical of the ability of a Medicare Board, as envisioned in the original Breaux-Thomas Medicare reform proposal, to escape such congressional micromanagement.

[9]Ibid., p. 25.

[10]For a description of how to accomplish this arrangement, see Walton J. Francis, "Using the Federal Employees' Model: Nine Tests for Rational Medicare Reform," Heritage Foundation Backgrounder No. 1675, August 7, 2003; and for an excellent description of the functioning of the premium support model, and how to organize such a system for future Medicare beneficiaries, see Jeff Lemieux, "Explaining Premium Support: How Medicare Reform Could Work," Centrists.Org, November 6, 2003, available at http://www.centrists.org/pages2003/10/26_lemieux_health.html.


Robert Moffit

Senior Fellow