American health care has undergone a revolution since Medicare began 40 years ago, a revolution based in no small measure on the program's actions. Today, a new health care revolution—one that encourages innovation and controls costs—is needed, and Medicare must again lead the way.
Before Medicare, the health sector was characterized by small businesses and solo practices offering a narrow range of services. Diagnostic testing was more dependent on the doctor's touch than sophisticated equipment. And Dr. Welby still made house calls, since virtually everything he could do in his office he could also do with his black bag.
The health sector is now a panoply of business organizations offering services that would have seemed like science fiction in 1965. Yet today's health care costs would also seem like science fiction to yesterday's policymakers and actuaries: Improvements in care have meant increases in national health spending, which has grown from 5.7 percent of gross domestic product (GDP) in 1965 to 15.4 percent currently.
Innovations and Coverage Gaps
America's seniors and disabled have generally been sheltered from the rising cost of their care by Medicare, which has guaranteed universal, heavily subsidized health coverage for a population now numbering some 40 million people. Supplemental coverage, primarily from retiree health plans and Medicaid, further insulated beneficiaries from the cost of care. Modeled after employer-sponsored health insurance that was typical in the 1960s, Medicare guaranteed that health care providers would be paid for all medically necessary services. Fee-for-service payment and low out-of-pocket costs fostered expansion in the use of health services, offering an expansive market for innovative new procedures and medical technologies.
However, Medicare benefits were slow to adapt to the changing practice of medicine and the growing needs and expectations of beneficiaries for health services. The outpatient prescription drug benefit which begins in January 2006 fills a long-standing gap in coverage that was filled years ago by typical group insurance policies. Medicare's delay in covering prescription drugs is the result of excessive regulation of the program by Congress, which has been mired in partisan debate over issues long since settled in private insurance markets.
Attempts to Control Spending Fall Short
Over the years, mounting program spending forced policymakers to try alternative payment approaches. Cost-based reimbursement gave way to prospective payment and the development of ever more complicated ways of defining both the service purchased and the amount paid. Despite the greater sophistication of these payment approaches, price setting rarely proved to be a binding constraint on spending, and program costs continued to spiral upward. When price setting was binding, as with the sustainable growth rate formula that threatens to cut physician fees by 30 percent over the next few years, policymakers made heroic efforts to ease the constraint.
In the mid-1980s, Congress allowed Medicare beneficiaries to choose between health plans for the first time. Instead of enrolling in traditional Medicare, beneficiaries could enroll in a private health plan that paid a fixed amount for the full care of the enrollee. Capitation payments provided an incentive to control patient cost, but entailed risks of under- and over-payment since rates were established by formula and didn't always reflect local market conditions. These plans became popular with Medicare beneficiaries in the early- to mid-1990s because of the extra benefits they offered, notably prescription drug coverage. Payment reductions enacted in 1997, however, caused a sharp decline in its popularity as benefits were cut back and hundreds of private plans dropped out of Medicare.
The Medicare Modernization Act passed in 2003 attempted to address some of the shortcomings of the program. The prescription drug benefit was made available to all beneficiaries, with a special subsidy to ensure that low-income beneficiaries would have full coverage. This was the first time Medicare has provided greater assistance with health costs to the less fortunate, rather than uniform subsidies for all regardless of need. In addition, centralized price setting for private plans (including the prescription drug plans) was dropped in favor of a system of bids to foster cost-saving competition among plans and ensure that federal payments reflected actual market conditions.
A Need for Reform
Greater reforms are necessary if Medicare is to meet the demands of the baby boomers, who are poised to double the program's enrollment over the next few decades. We can no longer afford to give Medicare beneficiaries the illusion that health care is a virtually free good. Instead, beneficiaries should be offered health plan choices reflecting the realistic costs of providing care. All health plans in Medicare, including the traditional program, should compete on an equal footing for enrollees. Subsidies should be structured to ensure that those with the greatest needs (in terms of both income and health status) get the greatest help.
Pricing should be as transparent and free of government controls as possible. Consumers (and their doctors) can hardly be expected to purchase wisely if they don't know the price. Similarly, if the price structure reflects political calculation rather than the combined judgments of millions of consumers and providers, policy-induced shortages and other market distortions will develop and health care resources will be wasted.
While Medicare falls short of offering a structure within which competition can flourish, it has made some strides in that direction. Effective competition can change the culture of entitlement that drives both patients and providers to demand more without regard to the impact on our country's ability to finance other pressing social needs. Effective competition does not require that every beneficiary respond to changes in prices or other market conditions, but it does require that those who want to exercise control over their health care have the opportunity to do so.
The problems of the U.S. health care system are larger than Medicare, but the program can play a pivotal role in addressing those problems. Because of its size and its position as an arm of the government, actions taken by Medicare inevitably will shape the broader system. After all, Medicare sets the rules by which health care providers, insurers, and health plans operate, even in their private businesses. So let us push for common sense reform that will encourage competition and control costs while still offering beneficiaries the coverage they need.
Joseph R. Antos is the Wilson H. Taylor Scholar in Health Care and Retirement Policy at the American Enterprise Institute and an adjunct professor in the School of Public Health at the University of North Carolina at Chapel Hill.
The views presented in this commentary are those of the author and should not be attributed to The Commonwealth Fund or its directors, officers, or staff.