Medicare Advantage, the new program of private health plans within the Medicare system, is a success. The main reason: Seniors enjoy an unprecedented level of personal freedom in choosing health care options that they think are best for them. Record numbers of senior and disabled citizens are enrolling in private health plans of their choice, securing better value for their health care dollars than is available to those who are enrolled in traditional Medicare. Of course, if they do not like their integrated private health plans, they are free to enroll in traditional Medicare and buy addi­tional supplemental coverage if they wish.

Congress enacted Medicare Advantage as part of the Medicare Modernization Act of 2003. While best known for creating the costly universal prescription drug entitlement, the Act also replaced Medicare Plus Choice (Medicare Part C)—a program created under the Balanced Budget Act of 1997 that allowed Medi­care recipients to choose coverage from among several private plans—with Medicare Advantage.[1] 

Medicare Advantage has several features that are superior to previous private health plan experiments: an improvement in financing and a greater level of market penetration and stability than Medicare Plus Choice. Most important, it gives senior and disabled citizens new and different private health plan options, more affordable care, and broader and better benefits, including care management programs and prescrip­tion drug coverage. Its key features:

• Broad Access to Private Health Plans. More than 9 million Medicare beneficiaries (roughly one of every five) are enrolled in private health plans under Medicare Advantage.[2]  While the heaviest enrollment is in urban areas, Medicare Advan­tage plans are now available in every region of the United States, including rural areas where private health plans have been sparse and diffi­cult to get. Total enrollment in Medicare Advan­tage plans has already surpassed Medicare's previous private plan enrollment.
  
• A Variety of Health Care Options. Seniors have a variety of options, which include health maintenance organizations (HMOs); local and regional preferred provider organizations (PPOs); private fee-for-service (PFFS) health plans; med­ical savings accounts (MSAs); and "special needs plans" (SNPs) that serve Medicare enrollees with chronic illnesses and disabilities. As of 2007, seniors had, on average, a choice of 20 differ­ent plans.[3] 
  
• Broader Health Benefits. The health plans cover all of traditional Medicare's benefits and much more. Seniors can choose plans with higher premiums and lower cost-sharing or lower premiums and higher cost-sharing. Beyond prescription drug coverage, the plans offer preventive-care services and provide coor­dinated care or care management programs for enrollees with chronic conditions. Plans also offer routine physical examinations, additional hospitalization and skilled nursing facility stays, routine eye and hearing examinations, and glasses and hearing aids.
  
• Superior Value for Health Care Dollars. Under Medicare Advantage, seniors have consistently been getting better value for their health care dollars in a system that is far superior to tradi­tional Medicare. Based on an analysis of addi­tional health benefits, including prescription drugs, hospital stays, and physician services, as well as premium savings in the Medicare Advan­tage system, the Centers for Medicare and Med­icaid Services (CMS) estimates that Medicare beneficiaries have secured, on average, an addi­tional monthly value of $96 (additional benefits or services worth that amount) by enrolling in a health plan in the Medicare Advantage pro­gram.[4]  CMS findings of this additional value provided by Medicare Advantage plans are in accord with independent private analyses. [5] 

The Next Stage of Reform

While these Medicare Advantage features are substantial improvements over traditional Medi­care, the next stage of reform must also make the total program affordable, modernize its insurance arrangements, and improve the delivery of medical services. Because of its unfunded liability, Medicare imposes an enormous burden on current and future federal taxpayers. According to the Medicare Trust­ees in their 2008 annual report, Medicare faces long-run excess costs of $36.3 trillion, based on a 75-year actuarial projection, or roughly two and a half times the size of the entire U.S. economy.[6]  While there is a need to improve and modernize the program's basic insurance functions, Congress must also address the severe mismatch between Medi­care's long-run costs and dedicated revenues.

Correcting Flaws. The Democratic congres­sional leadership wants to scale back Medicare Advantage, and Bush Administration officials have signaled their support of a presidential veto of any such cuts.[7]  Congressional opponents of the pro­gram say that Medicare Advantage health plans should not receive higher levels of Medicare fund­ing than traditional Medicare receives, even though the congressionally designed payment system for traditional Medicare, as many of these same Mem­bers of Congress are willing to concede, is flawed and routinely in need of legislative correction or modification.

A new system of premium support could estab­lish equity in Medicare payment, with positive results similar to the experience of the Federal Employees Health Benefits Program (FEHBP). Based on the FEHBP's almost five decades of experi­ence, the intense competition among health plans, driven by consumer choice, would deliver high-quality care to beneficiaries efficiently and without the level of mind-numbing congressional micro­management and frenzied provider lobbying that routinely burdens traditional Medicare.

No Illusions. Members of Congress must be honest and up-front about their intentions. Rarely are proposed Medicare Advantage payment cuts motivated by a newly found sense of fiscal respon­sibility: The program accounts for less than 15 per­cent of all Medicare spending. Rather, they areadvanced as new funding sources for even higher government spending, such as the proposed expan­sion of the State Children's Health Insurance Pro­gram (SCHIP).[8] 

What congressional opponents of Medicare Advantage also often do not say is that their pro­posed cuts in these private health plans are not really cuts in the plans, but cuts in seniors' health benefits. While these health plans get net payments that are approximately 12 percent higher than tradi­tional Medicare's per capita costs, they also provide more extensive benefits and more comprehensive health coverage.[9]  Under the legally ordained Medi­care Advantage bidding system established by Con­gress, any payments that exceed a health plan's bid must be returned to seniors in the form of lower cost-sharing or benefits, such as hearing, vision, and physical exams. So cutting payments to the health plans would mean, in effect, cutting these benefits for seniors.

Members of Congress should also be prepared to acknowledge that proposed Medicare Advantage payment cuts could result in another exodus of health plans from Medicare, as happened with con­gressional cuts in Medicare Plus Choice in 1997, when millions of seniors lost access to private health coverage. Traditional Medicare routinely covers only 54 percent of the total spending for beneficia­ries' health care.[10]  Without access to Medicare Advantage plans, seniors would have two choices: either settle for the inferior level of coverage of tra­ditional Medicare and go without the additional benefits or buy additional coverage through Medi­gap or some other supplemental coverage option. Meanwhile, the rollback of Medicare Advantage plans would impose a disproportionate burden on the low-income and minority seniors who enroll in them, as well as reduce seniors' access to Medicare Advantage plans in rural areas.[11] 

Achieving Parity. If Congress sincerely believes that parity of Medicare payment for different options is a desirable policy objective, then that worthy goal can be achieved through an equitable premium support system of financing, wherein the government contributes a specific amount to the premium cost of a health plan, that is combined with other measures, such as the creation of a risk adjustment mechanism for insurance, that will assure a level playing field for plan competition. In a Medicare premium support system, seniors would receive a direct contribution to the health plan of their choice. The money would follow the patient, letting the patient control the flow of dollars. This is the kind of financing that governs the popular and successful FEHBP. With seniors directly controlling the flow of Medicare dollars, all Medicare plans would either provide value—high-quality benefits and service for their premium dollars—in a robust competitive environment or lose market share.

If Congress is concerned with assuring some measure of fairness in the distribution of govern­ment funds to seniors, then it could easily adopt a system of income-related subsidies, providing more help to lower-income seniors and less to those with higher incomes. This policy has been partially in effect since 2007 through rule changes in Medicare Part B that require upper-income beneficiaries to pay slightly higher premiums.[12]  This policy could easily be applied to the entire Medicare program. It may be, as the Government Accountability Office (GAO) and many health care economists have sug­gested, more efficient to target subsidies directly to a defined low-income population than it is to subsi­dize premiums and cost-sharing for all Medicare beneficiaries, including those who are "well off."[13] 

Why Congress Created Medicare Advantage

Medicare Advantage is the latest generation of private health plan competition in Medicare, a fea­ture of the Medicare program since 1972 when Congress enacted legislation to allow health mainte­nance organizations (HMOs) to provide coverage for Medicare beneficiaries. Initially, Congress paid plans based on the average per capita costs of pro­viding traditional Medicare services in different geo­graphic areas or, alternatively, on what Medicare officials determined to be the "reasonable cost" of providing such services.[14]  Later, in 1982, Congress set Medicare payments to private health plans at 95 percent of traditional Medicare payments in each county, and the number of plans increased rapidly but not uniformly. There were still areas of the country where there were no private health plan options at all.

Based on a desire to expand the availability of health plan options, as well as a growing dissatisfac­tion with its own administrative payment formula for private plans in Medicare, Congress created the Medicare Plus Choice program as part of the Bal­anced Budget Act of 1997—a compromise between the Clinton Administration and the congressional Republican leadership—to replace the previous sys­tem of private health plans (mostly HMOs) with tight networks of doctors and other medical profes­sionals. The rationale for the new program was to "allow beneficiaries to have access to a wide array of private health plan choices in addition to traditional fee-for-service Medicare" and to "enable the Medi­care program to utilize innovations that have helped the private market contain costs and expand health care delivery options."[15] 

Loss of Private Coverage. The effort, plagued with unintended consequences, backfired: With the enactment of the Balanced Budget Act of 1997 and the creation of the Medicare Plus Choice program, Congress changed the payment policy and autho­rized the Medicare bureaucracy to set in place a series of new regulations on private plans. The impact was twofold: Congress authorized capping payment increases in the plans while expanding the Medicare bureaucracy's regulatory reach over their operations.[16] 

This combination was deadly and caused the number of private health plans in the Medicare pro­gram to drop by more than half.[17]  In 1998, the first year of the new Medicare Plus Choice program, 346 health plans were offered to senior and disabled cit­izens; by 2003, that number had sunk to 151.[18]  While millions of seniors lost the opportunity to enroll in alternative health plans, the congressional architects of the policy cynically blamed the private sector for the results of their own handiwork.

With the enactment of the Medicare Moderniza­tion Act of 2003, Congress changed policy again, reversing the cuts it had enacted in the late 1990s and approving additional funding to lure private plans back into Medicare. The private sector responded with an additional set of benefits and health plan options. While the program got off to a rocky start,[19]  the end result was a dramatic reversal of the dismal downward trends in private health coverage that had been set in motion under the restrictive 1997 Balanced Budget Act. The number of private health plans competing in the Medicare Advantage program increased rapidly.[20]  That rapid increase has resulted in the highest enrollment in private health plans in the history of Medicare.

The richer benefits package in Medicare Advan­tage, including disease management and care coor­dination programs, would prove to be particularly attractive to seniors with chronic medical condi­tions and would mitigate potential adverse selection against traditional Medicare that critics of partici­pating private health plans historically have feared.

The very presence of competing private health plans and the increasing demand for their services have also had a positive impact on the management and costs of traditional Medicare. In a recent study on the impact of Medicare HMO penetration on tra­ditional Medicare itself, researchers found a "spill­over effect" from such geographical penetration: Areas where such penetration was high also had lower costs in traditional Medicare. Specifically, examining county data, researchers found that a 1 percent increase in Medicare HMO penetration would reduce annual spending in traditional Medi­care by 0.9 percent.[21] 

Likewise, Jeff Lemieux, a former analyst at the Congressional Budget Office (CBO), also correctly predicted that a "big surge" in enrollment in this alternative program would encourage Medicare administrators to find ways to make traditional Medicare more efficient.[22]  The rapid popularity and growing success of Medicare Advantage could also encourage administrators of traditional Medicare to modernize their delivery of care as well as their pay­ment practices. This could then establish the groundwork for traditional Medicare to compete directly with private health plans in a new premium support system to provide the best medical care for senior and disabled citizens.

How Medicare Advantage Is Financed

Under the Medicare Modernization Act of 2003, the Secretary Health and Human Services (HHS) determines a benchmark payment equal to the maxi­mum amount that Medicare will pay private health plans for providing all Medicare Parts A and B benefits and hospital and physician services in a given geo­graphic area. The CMS benchmarks are based in part on projected Medicare costs at the county level and are updated annually. Under current law, the govern­ment benchmark must be "at least as great as per cap­ita" traditional Medicare expenditures in every county and, as the CBO observes, in many counties are higher than traditional Medicare expenditures.[23] 

When a health care organization wants to partic­ipate in Medicare, it must submit a bid with an esti­mate of its per capita payment for providing Medicare Parts A and B benefits. Estimates must also be submitted for prescription drug benefits, as well as for any additional benefits not covered by Medicare. Plan bids are risk-adjusted according to CMS rules, which means that the plan's estimate reflects the characteristics of the Medicare popula­tion in specific geographic areas. Plan estimates also include the administrative costs or profits that the plan projects. The CMS reviews and approves the bids for the plans.

Rebates to Beneficiaries. Under Medicare law, if a health plan's bid is higher than the government's benchmark payment for the core benefits in tradi­tional Medicare, the Medicare beneficiary is respon­sible for paying the difference in the form of a higher premium for enrolling in the plan. If, on the other hand, a bid is lower than the government's benchmark, 75 percent of the difference between the bid and the benchmark must be returned to the Medicare beneficiary as a rebate; the other 25 per­cent of the difference is to be returned as savings to the government.

Overwhelmingly, health plans offer the core Medicare benefit package at levels below the govern­ment benchmark. In 2006, 95 percent of Medicare Advantage plans bid below the government bench­mark.[24]  Rebates to Medicare patients can be in the form of lower cost-sharing, including lower copay­ments and lower premiums, or the provision of additional or enhanced benefits, including more affordable drug coverage. Under current CMS rules, the health plans have a high degree of flexibility in this matter.

Risk Adjustment. A key component of the new financing for private health plans is a more sophis­ticated system of risk adjustment. When health care organizations bid to cover enrollees in a given geo­graphical area for traditional Medicare benefits— the core Part A hospitalization and Part B physi­cians' services—the plan providers need to consider the level of risk they are assuming, which includes the variability among enrollees in terms of their health status or health risks, including the preva­lence of chronic disease, and patterns and costs of medical practice in a given geographical area. According to Dr. Gerald Kominski:

In this case, risk adjustment raises or lowers the premium [that] Medicare pays the plan, based on patient characteristics that have been shown to affect the risk that the enrollee will have higher or lower than aver­age health care needs. Without risk adjust­ment, premiums would not adequately reflect the expected costs of a plan's enroll­ees. This would have several consequences. Some plans would be overpaid while others would be underpaid.[25] 

While Medicare payments to private health care providers have previously been risk-adjusted, in recent years, the adjustment mechanisms have become more refined, going beyond demographic factors like age and sex to include measurements and classifications of medical conditions.[26] 

The Debate on Funding

At the heart of the current debate over Medicare payments to private health plans is the current stan­dard of payment: the traditional Medicare payment. In traditional Medicare, doctors and hospitals are paid through a complex system of pricing with fixed payments for hospital services based on hundreds of diagnostic categories, fee schedules for thousands of physicians' services, and ancillary formulas gov­erning annual payment adjustments and updates.

These payments are also adjusted geographically, so Medicare payments vary dramatically in different parts of the country, with per capita spending the low­est in Utah and the highest in Massachusetts.[27]  Con­gress's pricing system rewards high-priced providers in certain areas of the country and penalizes low-cost providers in others. According to one prominent study of this variation, total Medicare spending would fall by a stunning 29 percent if all Medicare spending were the same as spending in low-spending regions of the country.[28]  This means that there is a lot of unnec­essary spending embedded in the existing payment structure of the old Medicare program, which is hardly an ideal basis on which to base payments to health plans in a new program.

Arbitrary Pricing. Traditional Medicare sets and caps prices for medical services under Parts A and B. Few in Congress would defend their handiwork by pretending that Medicare's pricing represents prices that would survive in a real market in which the interaction of supply and demand determines the price of medical goods and services. As the CBO notes, Congress created and refined these pricing mechanisms over time, and they have yielded prices that are "below private sector levels" for payment to doctors and hospitals.[29] 

Over the years, Congress has attempted to refine pricing for medical services under Medicare Parts A and B with pricing mechanisms such as the Resource-Based Relative Value Scale (RBRVS)—the fee schedule for doctors' reimbursements—and the sustainable growth rate (SGR) formula for physician payment updates. These were, of course, initially presented as rational and fair and even, in the case of the RBRVS's, as scientific.[30]  In fact, they are noth­ing of the sort, and the Congress that consistently champions this price-setting process is annually engaged in a routine effort to change, modify, or even stop the progress of its own pricing machinery before it inflicts damage on the public and the med­ical profession. This is evident in the annual Chi­nese fire drill to prevent the legally ordained Medicare physicians payments cuts, which would reduce doctors' pay by 10 percent in July of 2008, from going into effect.[31] 

Traditional Medicare payments, in any case, do not reflect market prices. As Mark Merlis observes:

In some areas [Medicare] may be paying less than a market price for services, and in oth­ers more. At least in theory, competition among private health plans would more nearly ensure that providers were being paid the "right" prices than the current system of administratively set FFS payment rates.[32] 

Congressional critics, especially champions of Medicare's administrative pricing and price con­trols, argue that Medicare payments to Medicare Advantage plans should be reduced precisely because they exceed traditional Medicare payments. In calling for these cuts, these Members of Congress invariably cite the Medicare Payment Advisory Commission, which estimated that Medicare pay­ments for beneficiaries enrolled in private health plans were, on average, 12 percent higher than pay­ments for those enrolled in traditional Medicare in 2006. The CBO also estimated that "net payments" to these health plans in 2007 were 12 percent higher than the per capita costs of traditional Medi­care.[33]  The GAO and the Commonwealth Fund, a liberal health policy group based in New York, have likewise found that Medicare Advantage plans are paid at levels higher than the cost of traditional Medicare in different areas of the country.

Once again, however, the issue is the precise basis of comparison. To compare two different insurance systems with different levels of benefits and suggest overpayment because one is covering the benefits that the other is not is a classic apples-to-oranges comparison, and it only highlights the traditional Medicare program's serious gaps in not covering services that many seniors need and for which nine out of 10 must pay extra for supplemen­tal insurance.

As noted, Medicare Advantage payments include the payments for the extra benefits and services not included in traditional Medicare, integral to the legally binding rebate system, not merely the core benefits of Medicare Parts A and B. The issue is not simply what Medicare is paying, but what seniors are getting. As Merlis, among others, emphasizes:

These extra benefits are really at the center of the debate. Medicare continues to expose many beneficiaries to potentially catastrophic costs, especially beneficiaries whose incomes are too high to qualify for Medicaid and who cannot afford private Medigap coverage.[34] 

A Better Way? There is a growing consensus among both champions and critics of the Medicare Advantage program that the traditional payment system is flawed and should be corrected. Once again, the estimated net "overpayment" encom­passes high-cost and low-cost areas, and low-cost areas are where the traditional Medicare payment is often too low to enable private health plans to sur­vive. That is why congressional proposals to reduce Medicare Advantage payment to 100 percent of the traditional fee-for-service Medicare payment would result in the deepest cuts in health plans in tradi­tionally low-cost counties, while high-cost counties would be comparatively unaffected.

Dr. Robert Berenson, a senior fellow at the Urban Institute and one of the most prominent critics of the Medicare Advantage "overpayments," nonethe­less calls on Congress to recognize the serious flaws in the existing Medicare payment system at the county level and urges a new method of setting benchmarks by blending national and local rates, resulting in a more equitable payment system than we have today.[35] 

An even better option is a direct premium sup­port system of health care financing that enables all plans to compete. In some versions of premium support, this would include direct competition with traditional Medicare.

There are many ways to design a premium sup­port system for Medicare.[36]  One could base pay­ment, for example, on the average premium of competing health plans themselves rather than on a benchmark set by traditional Medicare pay­ments. But there would be neutrality in the gov­ernment's payment to health plans, including payment to traditional Medicare; if beneficiaries wanted to choose a health plan with a richer set of benefits, they could do so and would be responsi­ble for paying any additional amount over the government contribution.[37] 

Another option would be to pay health plans on the basis of an annual budget determination, whereby Congress explicitly decides how much it is willing spend on Medicare, factoring in the needs of the Medicare population along with other compet­ing budgetary considerations. This is broadly simi­lar to global budget proposals often proffered by champions of a "single-payer" health care system.

Yet another option is to combine a payment based on a market-based bid combined with a capped dollar amount based on the average pre­mium payment, which is very much like the FEHBP. Beyond the setting of the basic Medicare payment, however, Congress may wish to adjust that payment further for age, health status, and income—adjust­ments absent in the FEHBP payment system.

Superior Quality and Benefits

Medicare Advantage plans cover all of the health benefits that are included in traditional Medicare Part A and Part B programs—the hospital and physicians' services, respectively—but Medicare Advantage plans improve on traditional Medicare, adding new medical benefits that are not currently provided under the traditional program. Under traditional Medicare, for instance, a patient would pay an initial hospital deductible of $1,024, with a graduated per diem coinsurance; but Medicare Advantage plans include a variety of hospital copayments, and many offer unlimited hospital stays.

Likewise, under traditional Medicare, the patient would pay a $135 deductible and 20 percent coin­surance for physician services, with no limit on out-of-pocket expenses; but many Medicare Advantage plans offer physician benefits with no deductible and limited copayments.

With prescription drugs, as provided under Medicare Part D, the government standardizes the drug benefit, prescribing a $275 deductible monthly premium for insurance coverage, but with a deliber­ate gap in coverage: the so-called donut hole, where Medicare patients would have to pay 100 percent of the drug costs until a pre-specified upper limit is reached. With the regulatory flexibility provided to Medicare Advantage plans, seniors may pay no deductible or copayment, depending on the plan they choose, and be able to secure some level of cov­erage in the "gap," allowing them to get coverage for generic and brand-name drugs. The Medicare Advantage plans can and often do use their rebates to reduce Part D prescription drug premiums, bene­fiting millions of seniors.

The plans in Medicare Advantage have proved their worth. As of 2005, they provided lower copayments and deductibles for the required Medi­care-covered services; sensible out-of-pocket limits on medical spending for certain benefits; more gen­erous drug benefits than are generally available through the combination of traditional Medicare and a prescription drug plan; coordination of care for chronic illnesses including heart disease, diabe­tes, lung disease, and cancer; nutritional, wellness, and preventive benefits; and dental and vision ben­efits.[38]  Of particular interest in this connection is the demand for special needs plans that focus on chronic conditions. As of 2007, CMS approved 476 such plans, which have a total enrollment of 843,000 beneficiaries.[39] 

A key issue in Medicare financing is not simply the level of health care spending, which will accel­erate in any case with the retirement of the baby-boom generation. Even more important, the issue is what patients and taxpayers are getting in return for that spending. This should be measured in terms of results, better medical outcomes, and greater suc­cess in curing and treating diseases. So quality is another key component of sound health policy. While there are more refined definitions of quality of care, it can be summarized as getting the right diagnosis and the right treatment at the right time. Recently, CBO Director Peter Orszag said that he had not seen sufficient data from health plans or the CMS on the performance of the plans in delivering superior outcomes. Health plans, of course, are working to produce those data, which are sure to be enlightening.

Nonetheless, there is some preliminary evi­dence—such as data in reported in The Journal of the American Medical Association, the Archives of Internal Medicine, and The American Journal of Public Health—that Medicare Advantage patients are receiving care superior to that provided to patients in traditional Medicare. In a summary review of these findings, researchers at America's Health Insurance Plans, a national trade association with nearly 1,300 member companies, report that Medi­care Advantage plans outperform traditional Medi­care in providing beta-blockers after heart attacks, breast cancer screening, immunizations for the flu, and diabetes testing. Medicare Advantage patients were also less likely to have late-stage cervical and breast cancer diagnoses.[40] 

More Affordable Care. The GAO recently found that more than nine in 10 health plans submitted bids that were lower than the government's bench­mark and returned these savings to seniors in the form of lower costs. According to the GAO, 91 per­cent of those plans got an average rebate of $87 per member per month, and 89 percent of those rebates were returned to beneficiaries as lower copayments and coinsurance, as well as premium reductions.[41]  Eleven percent of the rebate payments went to Medi­care beneficiaries in additional health care benefits that are not covered by traditional Medicare.

Of course, the GAO also found that some bene­ficiaries who enrolled in certain plans could face higher out-of-pocket costs for certain benefits, such as home health care and inpatient services, than those enrolled in traditional Medicare.[42]  These ben­eficiaries can always switch to what they determine to be a superior option.

The GAO also found that 87 percent of the total Medicare Advantage revenues went to pay medical expenses for seniors, while 9 percent went to a com­bination of administrative and marketing expenses and competing plans were able to secure a profit of 4 percent.[43]  While the GAO found that approxi­mately 1.7 million seniors were enrolled in plans where less than 85 percent of revenues were spent on medical expenses, the overall Medicare Advan­tage level is generally higher than that of existing Medigap policies and approximates that of health plans in the private sector.[44]  Given the fact that most seniors have chosen to enroll in managed care options, which naturally have a higher level of administration, this distribution of revenues is hardly unreasonable.

A variety of reports from different government agencies show a consistency in provision of afford­able health care options for seniors under Medicare Advantage. When the program was implemented in 2004, the new funding for private plans was imme­diately directed to enhancing benefits and reducing beneficiary costs. As a result of the funding changes in 2004 and 2005, 95 percent of the funding increase was used by the plans to reduce premiums and cost-sharing for the beneficiaries, enhance their benefit offerings, and ensure increased access to doctors and other medical professionals.[45] 

These findings are confirmed by private-sector analyses. In a recent study for the Kaiser Family Foundation, Mark Merlis found that, compared to seniors enrolled in traditional Medicare, those enrolled in Medicare's rapidly growing private fee-for-service plans would receive benefits valued at $55.92 per month more than traditional Medi­care benefits and those in other Medicare Advan­tage plans would be able to get additional benefits valued at $71.22 higher per month.[46]  Merlis points out that if the sickest and highest-cost enrollees (with health spending that would have placed them in the top 5 percent of all Medicare beneficia­ries) were to choose a private fee-for-service plan, they would have higher out-of-pocket spending than "comparable enrollees" in other Medicare Advantage plans, amounting to an additional $1,000 a year.[47] 

Once again, beneficiaries have their own per­sonal reasons for picking different options, even if their personal out-of-pocket spending might be higher. Consider the rapid growth in PFFS health plans, particularly in rural areas. The private fee-for-service option may be increasingly popular among seniors precisely because it is a private fee-for-ser­vice option, and they can go to any doctor or spe­cialist they want. These plans are not burdened by the network restrictions on physicians and other medical professionals that are characteristic of man­aged care plans, particularly HMOs.[48]  Given the strong consumer backlash against managed care in recent years, this should not be at all surprising.

Medicaid Savings. Equally notable is the 2005 study conducted by Adam Atherly, professor at the Rollins School of Public Health at Emory University, and Ken Thorpe, formerly a senior health policy expert in the Clinton Administration. Atherly and Thorpe found that for senior and disabled citizens enrolling in a Medicare Advantage plan, the pro­gram would provide an additional $3 billion in ben­efits a year, or $615 per enrollee.[49]  But their more interesting finding is that this provision of addi­tional benefits for seniors would also result in a reduced reliance on Medicaid, the huge govern­ment program for the poor.[50]  In other words, by reducing dependence on the increasingly expensive Medicaid program, taxpayers at both the federal and state levels would gain significant savings from the expanded enrollment in Medicare Advantage.[51] 

Just as there are significant geographical varia­tions in the cost of traditional Medicare services,[52]  the premiums for private health plans, including those competing for consumer dollars under Medi­care Advantage, would vary by geographical region. In many areas of the country, Medicare beneficiaries can enroll in a health plan with a "zero premium" option, meaning no additional premiums beyond the Part B premium, or secure rebates that would reduce these Part B premiums.

Strong Minority and Low-Income Participation. Affordability of health care options is, of course, uni­versally attractive, but it is worth noting that Medicare Advantage has proven to be especially attractive to low-income and minority Medicare beneficiaries.

In their 2005 study, Atherly and Thorpe found that Medicare beneficiaries with incomes between $10,000 and $20,000 registered significantly higher enrollment in Medicare Advantage plans than in other options: Nearly 38 percent chose to enroll in Medicare Advantage, compared to 33 per­cent who opted for a Medigap plan or just over 29 percent who had Medicare only.[53]  Atherly and Thorpe also found that black and Hispanic benefi­ciaries showed a disproportionately greater enroll­ment in Medicare Advantage plans than did white beneficiaries: Nearly 33 percent of white beneficia­ries who had Medicare Advantage plans available to them chose them, while fully 40 percent of black seniors and nearly 53 percent of Hispanics selected them.[54]  Atherly and Thorpe estimated that the then-proposed congressional reductions in pay­ments to Medicare Advantage plans would likewise significantly and disproportionately affect these low-income and minority beneficiaries.

Premium Support: Building on the Success of Medicare Advantage

Medicare Advantage has been a success, but it is far short of comprehensive Medicare reform. Mem­bers of Congress who wish to see a fair and equita­ble Medicare payment system can achieve that most easily through a new system of premium sup­port in which all plans could compete on a level playing field.

A first-order decision is how to budget for future Medicare spending. Congress could make an annual budgetary decision on what will be spent for Medicare, based on an assessment of its entire set of fiscal obligations, and make Medicare payments accordingly, allocating a specific amount to Medi­care beneficiaries on a per capita basis.[55]  Congress could also pay Medicare plans based on the prevail­ing market rates of health plans in a competitive environment, reflecting the dynamics of a changing market but cap the payment amount, as is done to today in the FEHBP.

A second-order decision is whether to include traditional Medicare in health plan competition or whether to maintain the competition among private health plans alone in a new premium support sys­tem exclusively for new retirees.[56]  If policymakers decided to include traditional Medicare in a head-to-head competition with private health options, they would have to make significant programmatic and administrative changes to Medicare to enable Medicare to compete effectively.[57] 

In developing a new system, Congress can build on the success of Medicare Advantage while bor­rowing the best features of two other working mod­els: Medicare Part D, the competitive Medicare prescription drug program, and the popular and successful Federal Employees Health Benefits Pro­gram (FEHBP), a consumer-driven system of com­peting private health plans that serves federal workers and retirees and their families.

Learning from Part D. As in the FEHBP, drug plans in Medicare Part D bid against each other. Part D also features transparency, registers high patient satis­faction, and is characterized by intense competition and dramatic cost control. Since the inception of the competitive program in 2006, average monthly drug premiums for seniors have declined by almost 40 per­cent.[58]  In sharp contrast to virtually every other area of the health care sector, the intense market competi­tion in this program is driving costs down for both seniors and taxpayers. On average, seniors are saving $1,200 every year on their drug prescriptions.[59]  HHS Secretary Michael O. Leavitt has suggested the right policy: Make Medicare Parts A and B more like the competitive system in Medicare Part D:

If the Medicare Part D structure was applied to Parts A and B, it would revolutionize the entire system. Imagine, if you will, a physi­cian practice investing resources to monitor and to track patients with chronic condi­tions. [It] might, if the program provided beneficiaries with information on the quality of their care and especially if we rewarded it financially. It would drive quality up and the cost down.[60] 

To the extent practicable, the Congress should follow the example of FEHBP. There is a wealth of literature on FEHBP as a model for a future Medi­care program.[61]  It is free of the stultifying bureau­cracy, benefit standardization, price controls, and regulatory overhead that tie up doctors, hospitals, and medical professionals in red tape and bury them in paperwork. Historically, the consumer-driven FEHBP not only has outperformed conven­tional employer-based insurance in terms of cost, but also, when controlling for the value of benefits, has matched or surpassed even traditional Medicare.[62] 

In designing a new premium support system for Medicare, Congress should adopt five principles:

1. Government payments should be based on real market conditions. Government payment should not be based on traditional Medicare's artificial benchmarks, but on the real-life pre­miums charged by competing health plans. Congress should develop the new payment sys­tem on the basis of the FEHBP and Medicare Part D, not Medicare Advantage. In the FEHBP, the government sets the level of the contribu­tion at a percentage of the average weighted premiums (72 percent) of all health plans com­peting in the system. In Medicare Part D, the government pays health plans a risk-adjusted payment based on the average of plan bids for covering enrollees' drug costs.
   
   
2. Government payments should not be open-ended.In this instance, Congress could follow the example of the FEHBP, which, while setting the government standard on the average pre­mium payment, also caps the dollar amount per capita that the government will pay toward a health plan. The cap could be based, as noted, on the average premium of competing plans in the program or on a legislatively budgeted amount. In either case, a cap would encourage health plan providers to offer their benefits at competitive prices. Such a policy would also allow beneficia­ries to pay more than the capped amount for more expansive plans with richer benefits.
   
   
3. Government payments should encourage beneficiary savings. Ideally, beneficiaries should be able to secure the full savings of any choices that they make, which means that they would be able to pocket 100 percent of the dif­ference between the government contribution and the price of a lower-cost health plan. Under Medicare Advantage, the beneficiaries can secure only 75 percent of the savings from choosing a plan that offers a product at a price below the Medicare benchmark. Under the FEHBP formula, the government contribution for federal employees and retirees is limited to 75 percent of the premium cost of any compet­ing health plan, upto the capped amount.
   
   Incidentally, the FEHBP's own payment for­mula could be improved. If the government contribution in that program were permitted to reach 100 percent of the capped amount, it would encourage federal employees to choose less expensive plans, gaining savings for them­selves as well as for taxpayers. Such an arrangement should be provided to future Medicare beneficiaries in any new premium support system.
   
   
4. Government payments should be risk-adjusted. Remarkably, the FEHBP has no risk adjustment system. In this case, Congress should build on the success of Medicare Advan­tage, which has made significant progress in developing and applying risk adjustment. This is particularly important for beneficiaries who are older, who have higher health care costs, or who suffer from chronic diseases.
   
   
5. Government payments should be income-related. While every Medicare beneficiary who financially supports the program through taxes should be guaranteed a reasonable benefit, any new premium support system should also rec­ognize the vast differences in financial need and in the ability to pay for insurance premiums and medical services among a very diverse pop­ulation of future beneficiaries. This principle is modestly advanced under Medicare Part B, which requires higher premiums for high-income beneficiaries.
   
   Under a new premium support system, govern­ment payments should also be income-related. Such a measure could strengthen a future Medicare program and, given the fiscal chal­lenges facing Medicare, could also win the sup­port of liberals and conservatives alike. As Stuart Butler and Maya MacGuineas argue, "Rather than being seen as breaking the web of mutual obligations that bind us together as a community, means testing should be seen as enabling us to strengthen the safety net so that no one falls through."[63]

Conclusion

The Medicare Advantage program is a success. Medicare patients are choosing health care options they like; they are getting superior benefits at afford­able prices, and health plans are competing to pro­vide value for health care dollars. By purchasing an integrated health plan, seniors are not forced to pay an additional premium for an additional private health plan, supplemental coverage, or drug plan to cover the needed benefits that traditional Medicare does not provide.

There are clearly problems with the payment methods for Medicare Advantage plans—mostly problems that stem from basing the methods on the flawed payment system of traditional Medicare. Medicare payments do not reflect real market con­ditions of supply and demand, but rather are the product of a highly politicized administrative pric­ing mechanism, replete with price controls that yield results that are often absurd or unacceptable, as in the case of Medicare physician payment.

Medicare Advantage plans are not "overpaid" if the value of the benefits that they are providing is factored into the calculation. Under traditional Medicare, seniors need to pay an additional pre­mium and buy supplemental coverage to secure the missing benefits they need or the extra benefits that they want that are not included in the traditional program. With Medicare Advantage, beneficiaries are getting access to an integrated package of bene­fits, just like their fellow citizens who purchase group or individual insurance in the private mar­kets, and can dispense with the hassle of two pay­ments for separate insurance products. Meanwhile, the reliance of lower-income seniors on Medicare Advantage reduces their reliance on Medicaid, a welfare program, and thus produces reductions in Medicaid spending.

For future generations to be able to afford Medi­care, the program will have to be restructured and reformed. For that reform to be successful, Con­gress will have to reform the existing payment sys­tem and provide a fixed-contribution system of premium support, properly adjusted, for each ben­eficiary. At the same time, Congress should make sure that Medicare enters into a reliable partnership with private-sector health plan providers—and soon. In other words, the government will have to prove itself to be a good business partner.

Robert E. Moffit, Ph.D., is Director of the Center for Health Policy Studies at The Heritage Foundation.