The FEHBP as a Model for Reforming Medicare

Testimony Health Care Reform

The FEHBP as a Model for Reforming Medicare

March 20, 2002 15 min read
Stuart Butler

How Medicare could be reformed to incorporate the lessons from the FEHBP

Key features of the FEHBP

  • There is no single, comprehensive standardized benefit package in the FEHBP, unlike Medicare, yet benefits are up-to-date - because of consumer demand and negotiation, not because of legislation.
  • The FEHBP offers a wide range of plans, with a variety of benefits, and yet experiences surprisingly small problems of adverse selection.
  • The FEHBP uses negotiation, not formulas, to establish premiums and payments to plans.
  • The FEHBP plans include several offered by employee organizations and unions.
  • The FEHBP has a comprehensive system of information distribution to aid beneficiaries making choices.

How Medicare could be reformed to incorporate the lessons from the FEHBP

1) Remove from CMS the function of managing a competitive market of managed care plans and the traditional fee-for-service program and instead place this function under a new Medicare Board with powers to negotiate prices and services with plans.
2) To enable the basic 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.
3) Empower the traditional fee-for-service program to compete.
4) Amend the plan payment system to make it more like that used in the FEHBP.
My name is Stuart Butler. I am Vice President for Domestic and Economic Policy Studies at The Heritage Foundation. I must stress, however, that the views I express are entirely my own, and should not be construed as representing the position of The Heritage Foundation.

It is wise of the Committee to explore the applicability of the Federal Employees Health Benefits Program (FEHBP) as a model for reform of the Medicare program. The FEHBP, which is run by the Office of Personnel Management (OPM) is an interesting contrast to Medicare. Both are large health care programs run by the federal government. But there the similarity ends. The FEHBP is not experiencing the severe financial problems faced by Medicare, and nor are there complaints that it lacks important benefits, such as drug coverage. It is run by a very small bureaucracy, which, unlike Medicare's staff, does not try to set prices for doctors and hospitals. It offers choices of modern benefits and private plans to federal retirees (and active workers) that are unavailable in Medicare. It provides comprehensive information to enrollees. And it uses a completely different payment system, blending a formula and negotiations.

It is time for Congress to examine closely the system they are enrolled in themselves and incorporate key features of the program into Medicare.

How the FEHBP works

Created by Congress in 1959, the FEHBP offers about 200 competing private plans to active and retired Members of Congress and congressional staff, as well as active and retired federal and postal workers and their families -- altogether almost 9 million people. Enrollees in any location have a choice of several plans, including national plans. The FEHBP population is by no means an ideal insurance pool. For one thing, the average age of the FEHBP population of active employees is rising, as is the proportion of higher-cost federal retirees in the program. In addition, plans may not impose "waiting periods" or limitations or exclusions from coverage for pre-existing medical conditions, nor can they base premiums on medical risk.

Federal workers and retirees can choose from a variety of health plans, ranging from traditional fee for service plans to insurance plans sponsored by employee organizations or unions, to managed care plans. HMOs in FEHBP have benefits that are especially attractive to the elderly, including catastrophic coverage and mental health coverage. Almost all cover care in an "extended care facility," some with no dollar or day limits. And unlike Medicare, most FEHBP plans cover prescription drugs and include a wide range of dental services. Furthermore, the elderly can choose plans with specialized items, such as diabetic supplies.

How The Elderly Pick Plans
Each year, in preparation for the fall annual "Open Season," when retirees and regular employees pick plans for the following year, OPM sends beneficiaries an FEHBP Guide, which includes a standardized health plan comparison chart. There is also an excellent website that allows plan comparisons to be made. Health plans also provide retirees with information on benefits and premiums in a variety of ways, including advertising. Perhaps the most valued consumer resource for federal employees and retirees is Checkbook's Guide to Health Insurance Plans for Federal Employees, published by a consumer organization. The popular Guide compares plans, gives employees and retirees general advice on how to pick a plan, outlines plan features and special benefits, presents detailed cost tables (including the out-of-pocket limits for catastrophic coverage), and presents "customer satisfaction surveys" on the performance of plans. The Guide also provides specialized advice for federal retirees, including retirees with and without Medicare and information on HMO options and Medicare.

The Guide's "customer satisfaction surveys" are quite detailed, rating plan performance in such areas as access to care, the quality of care, the availability of doctors, the willingness to provide customer information and advice by phone, the ease of getting appointments for treatments or check-ups, typical waiting times in the doctor's office, access to specialty care, and the follow-through on care. The surveys also review patient experience with such things as an explanation of care, the degree to which the patient is involved in decisions relating to care, the degree to which the plans' doctors take a "personal interest" in the patient's case, advice on prevention, the amount of time available with the doctor, the available choice of primary care physicians and access to specialists, and the speed with which the patient can contact the plan's service representative.

Beyond this valuable information, organizations representing enrollees also provide information. For example, federal retirees can receive additional guidance from the National Association of Retired Federal Employees (NARFE), a private organization representing approximately 500,000 current and retired federal employees. With a network of over 1,700 chapters throughout the country, NARFE works closely with the OPM in answering questions and resolving problems related to health insurance and retirement matters. In preparation for "Open Season," NARFE publishes its annual Federal Health Benefits and Open Season Guide. Most important of all, NARFE actually rates plans on benefit packages that would be most attractive to the elderly.

The Role of the Office of Personnel Management
OPM is given authority in the FEHBP statute to: contract with health insurance carriers; prescribe "reasonable minimal standards" for plans; prescribe regulations governing participation by federal employees, retirees and their dependents, as well as to approve or disapprove plan participation in the FEHBP; set government contribution rates in accordance with federal law; make available plan information for enrollees; and administer the FEHBP trust fund, the special fund containing contributions from the government and enrollees and from which all payments to health plans are made.

Unlike Medicare, OPM does not impose price controls or fee schedules, or issue detailed guidelines to doctors or hospitals or standardize benefits. By law, private plans within the FEHBP must meet "reasonable minimal" standards regarding benefits. But the law creating FEHBP does not specify a comprehensive set of standardized benefits. Congress merely defines the " categories" or "types" of benefits that are to be provided; the level or duration of medical treatments or procedures is largely left to negotiation and the choice of enrollees in a dynamic market.

The Premium Negotiation Process
OPM sends out a "call letter" in the Spring of each year to insurance carriers, inviting them to discuss rates and benefits for the following calendar year. In these confidential discussions, OPM outlines its expectations on rates and benefits to the carriers, and the carriers invariably respond by offering proposals for packages and premiums. Government managers negotiate premiums before they are posted for the open season. This is a largely successful mixture of discussion and jawboning.

For HMO and point of service (POS) plans, OPM typically starts its negotiations based on the local market for these plans - it does not, as in the case of Medicare, apply a formula based on the local fee-for service market. In the case of fee-for-service and preferred provider organization (PPO) plans, OPM negotiates a fixed profit per subscriber. Thus the plans make money through negotiated service contracts rather than traditional profits. While these plans must accept market risk, they must lodge revenue surpluses in special reserve accounts.

To some extent this negotiation system means the government exercises "price maker" power. But the plans still must design and price their product shrewdly in strong competition with each other for enrollees if they are to remain in business. Significantly, OPM devotes most of its negotiating energy with the large plans that determine the government's maximum contribution, and largely ignores the pricing of other plans. It is not clear that the government's jawboning function in the FEHBP is as important in holding down costs than this competition for price-sensitive enrollees. But what is clear is that OPM bargaining with competing plans is far more successful at holding down costs than CMS issuing edicts to hospitals and physicians.

Other OPM Functions
In setting the government contribution to retirees health benefits, OPM make its calculations according to a formula established by law, under which OPM pays a percentage of the premium chosen by the enrollee up to a maximum dollar amount linked to the costs of certain comprehensive plans. Whatever the plan chosen, the government's premium is sent directly to the plan. The enrollee's premium contribution normally is deducted from the enrollee's paycheck (for workers) or annuity (for retirees) and also sent by OPM directly to the chosen plan. OPM also helps retirees and employees settle disputed claims.

OPM prepares kits outlining rates and benefits for the coming calendar year, disseminating information on the plans. Beneficiaries then pick a plan during open season. OPM maintains an "Open Season Task Force" to help in making decisions, and a hot line that retirees (or regular workers) can call during open season.


Congress could introduce key features of the successful FEHBP program into Medicare by taking several important steps.

1) Remove from CMS the function of managing a competitive market of managed care plans and the traditional fee-for-service program and instead place this function under a new Medicare Board with powers to negotiate prices and services with plans.

CMS currently is responsible for operating the traditional fee-for-service program. But is also responsible for establishing and managing the market for managed care plans that compete directly with its fee-for-service program. This mixed role or umpire and competitor conflicts with a basic principle of economic organization in a market - 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. Entangling the running of a market with the management of any of the competing providers is a recipe for problems. Significantly, 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 trial attorney.

The Breaux-Thomas Medicare Commission recognized this inherent conflict when a majority of members voted to establish a board to take over many of the marketing functions, and the management of private plans, now undertaken by CMS. To establish such a Board, Congress should create within the Medicare program a body that is the functional equivalent of the Office of Personal Management 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.

The new Board should answer directly to the Secretary of the HHS, and would have similar functions to those of OPM within the FEHBP. It would take over many of the Medicare functions currently assigned to CMS, leaving CMS's Medicare staff to focus on the administration of the fee-for-service Medicare program. Among the Board's functions:

  • Setting standards for all plans being offered to Medicare beneficiaries, and certifying that all plans meet those standards. The Board should be responsible for setting the "ground rules" for inclusion in Medicare, including solvency requirements and information requirements. 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 OPM negotiates with individual plans before they are offered to federal employees during open season, so the Board should be given latitude by Congress to negotiate premiums with managed care plans. This would be a marked improvement on the current formulas established by Congress, which lead to payment levels that are out of line with local markets. Under a system of premium/payment negotiation the Board would be able to balance the government's cost and the availability of plans in an area, something it is hampered from doing today.
  • Organizing payments to chosen plans. The Medicare Board would be responsible for the payments to plans.
  • 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 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 current CMS personnel. But it would be wise to recruit some staff from outside HHS in order to introduce new skills and experience. Some individuals might be recruited from OPM, and others from the private sector.

2) To enable the basic benefits package to be revised and improved steadily over time, the current politicized process for changing benefits should be replaced with a Benefits Boardand 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 as 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.

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 are necessarily entangled in the political process. Providers included fight hard and usually effectively to block hard 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 more on shrewd lobbying and political polling than on good medical practice.

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 steps:

  • Set only broad benefit categories in Congress. Rather than set detailed benefits in legislation, Congress should 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 program. In addition, Congress could establish the minimum "bare bones" benefits each plan must have - leaving the Medicare Board to negotiate additional benefits plan-by-plan.
  • Create a Medicare Benefits Board. Instead of Congress or the Administration specifying detailed benefits for the fee-for-service program (or the minimum benefits for managed care plans), Congress should create a Benefits Board to propose specific incremental changes in these core benefits. Such an independent board would have members selected for specific terms by the Administration and Congress. The package recommended by the Benefits Board would then 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, and 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.

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 reached.

3) 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 CMS, it is currently very difficult for the agency to make sensible improvements in the fee-for-service program to more it competitive and modern.

The Breaux-Thomas Medicare Commission discussed giving CMS 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 competition.
Congress should address this inflexibility by giving CMS 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 public education.

More specifically, Congress should give CMS 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 CMS should be granted greater discretion to introduce innovations into the management of traditional fee-for-service Medicare. It should be allowed, for instance, to make extensive use preferred provider organizations of those physicians and hospitals giving the best value for money. It should also be allowed to further contract out the management of the traditional program in areas where that might improve Medicare.

4) Amend the plan payment system to make it more like that used in the FEHBP.

A form of "premium support" financing much like that in the FEHBP is the best way to achieve the goals of a high-quality Medicare system that is affordable to taxpayers as well as seniors. Under an FEHBP-style payment system, Medicare beneficiaries would receive a percentage contribution to the cost of their chosen plan, up to a maximum dollar amount. But this mechanism can be adjusted so that the elderly and disabled are not at risk for long term changes in the cost of their health coverage. In fact, a premium support arrangement can be modified in several ways to address variety of policy goals and to protect enrollees. For example:

  • The maximum contribution could be adjusted each year - or indexed - to cover the market price of major plans providing comprehensive benefits. In that way the elderly would continue to have an entitlement and know that the costs of comprehensive coverage would be assured, but the premium support approach means they would also have a strong incentive to choose a cost effective plan.
  • A minimum amount of premium support could be established and this could be adjusted by income, so the low-income senior would have a larger amount of financial assistance for any given plan.
  • The minimum and maximum amount could be adjusted (i.e. indexed) to account for the higher costs of certain medical conditions warranting more elaborate coverage.

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Stuart Butler