My professional interest in Medicare regulation, and how to improve the financing and delivery of medical services to American citizens, is far from academic. During the Reagan Administration, I not only served as Deputy Assistant Secretary for legislation at the Department of Health and Human Services (1986-1989), handling congressional requests and constituent problems related to Medicare, but I also served as the Director of Congressional Relations at the United States Office of Personnel Management (1981-1986), the agency that administers the Federal Employees Health Benefits program (FEHBP), the model for reform embraced by the Bush Administration, the majority of the National Bipartisan Commission on the Future of Medicare and the model embodied in the legislative reform proposals recently introduced by Senators John Breaux(D-LA) and Bill Frist (R-TN). I have thus had a practical experience in monitoring and responding to congressional inquiries on both programs.

Concerning the Medicare's regulatory problems, I have several observations.

First, Medicare's regulatory complexity is not the fault of the Health Care Financing Administration (HCFA), the agency that administers Medicare. 
Criticism of the Medicare's regulatory regime should not be a criticism either of the career staff or HCFA as an agency of the federal government. This is not to exonerate the agency or its officials from some serious mistakes, or lapses in judgment. But much of the understandable anger directed at HCFA by doctors and medical specialists, and even Members of Congress is too often misplaced.

Growing dissatisfaction among providers over Medicare's regulatory burdens is not merely attributable to HCFA's managerial efficiency, or its lack of managerial efficiency. Rather, it is attributable to the seemingly incessant Congressional delegation of ever greater regulatory responsibilities to the agency, and, more importantly, to the very structure of the Medicare program itself. Medicare is an entitlement program; it is a defined benefits program, where Congress determines what benefits Medicare patients will get; and, subsequent to Congressional authority, HCFA and its contractors, determines what is or is not covered for purposes of reimbursement, and what specific medical services, and treatments and procedures Medicare patients will get and how, and under what circumstances they will get them. HCFA, again subject to Congressional authority, determines what is or is not appropriate or medically necessary. This is formidable regulatory authority. But it is difficult to imagine how Medicare, given its current structure, could function otherwise. Surely, HCFA's most severe critics would not want to surrender to the agency unlimited flexibility to carry out its mandate. If Congress wishes to retain this structure, then Congress must authorize, and HCFA must implement and enforce increasingly detailed regulations that guarantee universal access to a set of legislatively or administratively defined benefits, medical treatments or procedures.

Given this structure and this process, there will be numerous disagreements, powerful and angry dissents, and strong objections from medical providers, seeking exceptions or expansions to these rules. The regulatory exceptions simply complicate the regulatory environment.

So, HCFA's problems are not rooted simply in the absence of a superhuman wisdom, or any inherent deficiencies in HCFA staff to do the necessary regulatory job, or because the agency suffers from an absence of information technology specialists, or aging and outdated information systems unable to cope with the rapidly changing conditions. It is rooted in a work overload that, given the Congressional authorization, is unavoidable. These problems are not going to be solved simply by appropriating funds so that HCFA can acquire the right software or the right hardware, or the right specialists in whatever field of health care policy that is required. Given the current structure of the Medicare program, there is simply no way to avoid these difficulties.

Congress specifies what it will pay for benefits and services, and authorizes HCFA to make any adjustments in accordance with its legislative determinations, or the formulas, that govern Medicare's complex system of administrative pricing plus price caps, including the Prospective Payment System(PPS) for hospital payment and the Resource Based Relative Value Scale(RB-RVS) for physician reimbursement. As my colleague Dr. Len Nichols, a senior economist and health care policy analyst at the Urban Institute has noted, the task imposed on HCFA is to set roughly 10,000 prices in 3000 counties across the United States, a task which it does not, and cannot, do very efficiently or effectively.

On payment issues, as on the benefit issues, as Members of this Subcommittee know, far better than I would even be able to imagine, there are intense pressures to readjust constantly this formula driven Medicare payment system; carve out exceptions; and revise and refine the reimbursements upward. These pressures are invariably intensified after Congress has taken actions to reformulate reimbursements downward, in perennial attempt to control costs in the program. This annual political process also invariably adds to the growing complexity of the system, and makes its progressively less comprehensible for doctors, hospitals and other providers, and, of course, patients.

For the most part, Medicare patients are the passive recipients of this arcane and complicated decision-making process. Medicare's regulatory regime directly impacts only doctors, hospitals and other providers. Compared with the private sector, Medicare's administrative costs, as a percentage of payment for benefits, appears very low, roughly between 1 and 2 percent. But this calculation does not take into account the transactional costs of health providers in complying with this regulatory regime. A major econometric analysis of these costs, and their impact on patients, would be welcome.

Altogether, this process not only frustrates providers- doctors, hospital administrators or home health care officials - but also yields some very odd economic results. The General Accounting Office has done a number of studies on the subject, which make for interesting reading. Once again, if Congress retains the current structure of Medicare, there is simply no way around these problems or political pressures.

Second, HCFA is overwhelmed by the size and scope of its regulatory responsibilities, and is in a state of managerial crisis.
Once again, theregulatory responsibilities of HCFA are not, of course, generated by HCFA; they are imposed by Congress. And, as noted, they are elemental to the very structure of Medicare as a defined benefit entitlement program

Medicare today covers almost 40 million persons, at an estimated cost of $220 billion. As the General Accounting Office and others have pointed out ,HCFA also administers the Medicare Plus Choice program with over 300 managed care plans, and contracts out for the services of others, particularly intermediaries or insurance carriers, in every state in the union. HCFA pays approximately 6000 hospitals, and roughly 700,000 physicians and other providers. Moreover, HCFA must write standards, as a condition for participating in the Medicare program for a variety of institutions and specialties, such as hospitals, home health care agencies, clinical laboratories, nursing homes, skilled nursing facilities, among others. And beyond Medicare, HCFA also has responsibilities for running Medicaid, overseeing the State Children's Health Insurance Program, and enforcing certain provisions of the Health Insurance Portability and Accountability Act. Altogether, HCFA oversaw a total estimated payment of almost $370 billion for health care services last year. As GAO and others have also noted, it is progressively harder for HCFA to fulfill all of these responsibilities.

This managerial crisis has been developing over time. The General Accounting Office(GAO) told Congress in 1998 that " … substantial program growth and greater responsibilities appear to be outstripping HCFA's capacity to manage its existing workload." In 1999, 14 prominent health care policy experts, including Dr. Stuart M. Butler, my superior at the Heritage Foundation, and three former directors of HCFA published an open letter to Congress and the White House in the 1999 Winter issue of Health Affairs warning of an impending management crisis at HCFA. While these analysts differed on what was the best approach to Medicare reform, they were all agreed on one point: HCFA is, as an institution, in very serious trouble. Following up on this notice, in the October 2000 edition of Health Affairs, Dr. Lynn Etheredge of George Washington University, wrote, " The management crisis has arrived. …It is now widely recognized that HCFA has many problems. Reformers are frustrated, whether their goals are a successful Medicare+Choice Market, modernization of fee for service Medicare, enrollment of eligible children in SCHIP, improved computer systems, new chronic care programs, or better staff morale. Nearly everyone who works with the Medicare or Medicaid programs now understands that something needs to be done about HCFA." While there is an urgent need for action, there is an even more urgent need to do it right.

Third, Medicare's regulatory complexity compromises the quality and delivery of medical services and insurance products.
This is becoming evident in at least two areas: access to medical technology and in the use of private plans in the Medicare + Choice program.

In the area of medical technology, there is solid evidence that Medicare's processes are painfully slow and compromising patient access to technology that is available to patients in the private sector. Last year, the Lewin Group, a Virginia based econometrics firm modeling health care policy initiatives, conducted a major study on behalf of the Advanced Medical Technology Association that found that Medicare's processes of coverage, coding and payment decisions delay patient access to medical technology. The study found that it takes between 15 months to over 5 years or more to add new medical technologies to Medicare program. Moreover, according to the Lewin study, Medicare's processes for coverage, coding and payment is time consuming and complicated, and impedes patient access and discourages innovation in breakthrough medical technologies.

Likewise, the current regulatory regime has damaged the Medicare +Choice program. In their 2000 analysis of the Medicare+Choice program, The Medicare+ Choice Program: Is It Code Blue? Janice Ziegler and Bruce Fried, a former Director of the Center for Health Plans and Providers at HCFA, wrote, " The regulatory complexity of the M+C program has taken on mammoth proportions and made it difficult for M+Cos to comply with all of the many program requirements. Moreover the breadth and depth of regulatory requirements have imposed a level of micro-management that significantly hampers- or, in some instances, restricts altogether- the ability of M+COs to make essential business decisions regarding how care should be financed and operations structured. This level of micro-management, when coupled with constantly changing nature of the program requirements and conflicting directions from HCFA, creates a significant disincentive for M+COs to remain in the program or become new entrants."

As Fried and Ziegler report, beyond the issuance of detailed regulations and "guidance" and Medicare manual changes , HCFA has already issued well over 100 "operational policy letters" ( OPLs ), the specific directives governing various aspects of plan administration. Moreover, plans have had to meet HCFA's tight deadlines for compliance as well as various state regulatory standards, while wrestling with conflicting federal and state rules. Fried and Ziegler further note that HCFA issues these rules and letters often with little or no thought about how they will impact costs. But, of course, every dollar required to comply with HCFA's increasingly complex administration of the program means one less dollar for drug benefit increases or premium reductions for senior citizens.

Fourth , Medicare's regulatory complexity must get worse. 
With the rising demand for even more specialized and complex medical procedures within the current framework of the defined benefits system, the regulatory complexity will worsen. With the rising demand for medical services by a rapidly aging population, a Medicare eligible population that will double over the next three decades, the pressures to accommodate those increased costs within the existing framework of administrative pricing will intensify. Congressional debates over physician or hospital payment or reimbursement for home health or skilled nursing facilities, or whether or how to cover new medical devices or procedures, prescription drugs will require more Congressional time and attention and even greater administrative effort on the part of HCFA.

Fifth , the addition or expansion Medicare benefits, including a prescription drug benefit, without addressing the managerial and regulatory problems plaguing the program would be a profound mistake.
HCFA already faces serious challenges in running the traditional Medicare program and the beleaguered Medicare + Choice program, , which is processing roughly a billion claims each year. The addition of a Medicare prescription drug benefit to the current structure, whatever merits that may have, would also dramatically increase the number of transactions HCFA must oversee and thus add to the program's already formidable managerial burdens.

WHY STRUCTURAL REFORM EQUALS REGULATORY REFORM.

If Congress wants to strike at the root of the regulatory problems that affect the current Medicare program, then the remedy of choice is choice itself; a structural reform that preserves a Medicare entitlement to a basic or core set of health benefits, but transfers the lion's share of decision-making in the system over to Medicare patients and the private plans that they personally choose for themselves.

The best working model for such a structural reform, as the majority of the National Bipartisan Commission on The Future of Medicare have advised, is a program that is older than the Medicare program: the Federal Employees Health Benefits Program (FEHBP), which has been serving federal workers ands retirees and their families since 1960. Because the government contributes to the cost of the enrollees premium, rather than trying to pay medical providers directly or determine the details of health benefits or the precise level of medical services, the FEHBP is the quintessential "premium support" program.

Having been enrolled in the program personally and having been associated with the program professionally in my capacity as an Assistant Director at the United States Office of Personnel Management, I am acutely aware of the weaknesses of that program, specifically, a lack of variation in premiums or government contributions for younger workers and older workers and retirees or the absence of any risk adjustment mechanism to cope with periodically troublesome problems of adverse selection. Moreover, FEHBP does not yet accommodate flexible spending accounts, widely available to workers in the private sector, and OPM has had an institutional bias against lower cost, high deductible options for employees who might want them. There are also irrational statutory restrictions on market entry of fee for service plans, even though these plans tend to be more popular than HMOs.

Nonetheless the 40 year record of the FEHBP has been exceptionally good. This is particularly so in the area of governance. In 1989, in perhaps the most comprehensive analysis of the FEHBP ever undertaken, the Congressional Research Service noted that historically, the OPM has governed the FEHBP in a fashion that is best described as " passive management". While some might object to such managerial passivity, a positive by-product of OPM's historically light touch has been a progressive evolution of benefits packages, that have become richer and more varied with the passage of time.

Other students of the program- ranging from Professor Alain Enthoven of the University of California to analysts from the Progressive Policy Institute- have found that among its most attractive features is the brevity and relative simplicity of its statutory authority. The program is also characterized by the notable absence of heavily prescriptive regulation, the relative ease with which the program adopts new health benefits and absorbs new medical technologies, and its relative flexibility in benefit setting. From the vantage point of governance, the FEHBP also enjoys a relative freedom from the bitter politics of administrative pricing, the medical income redistribution and attendant Congressional micro-management that afflicts the traditional Medicare program. The major reason: In stark contrast to the Medicare program, the FEHBP is a largely market driven system, which relies on private sector plans to structure their offering each year to satisfy consumer demand and compete with each other directly in promoting patient satisfaction. Thus, in sharp contrast to Medicare, the crucial decision-making in the FEHBP is diffuse. While there are negotiations between OPM staff and major plans, and hundreds of routine transactions between OPM and private plans in the several states, there are literally millions of decision points in the system, governed by the diverse wants and needs of federal employees and their families and the dynamic conditions of supply and demand. Consider the main features of the program:

• Broad Choice of Plans. Over 300 plans are competing for consumers' business. Unlike the rest of working Americans, federal workers and retirees will have a broad choice of private plans from which to choose. These plans may be fee for service plans, preferred provider plans, (PPOs) or health maintenance organizations (HMOs). Unlike many workers in private sector, federal workers are not forced into one type of coverage, such as HMOs, on a "take or leave it" basis, and federal workers and their families can normally choose between a dozen and a dozen and a half plans in most places in America. Unlike Medicare enrollees, their private plans include prescription drug and catastrophic coverage. In fact, virtually all plans cover between 80 and 90 percent of prescription drug costs.

HMOs attract federal employees and retirees, and they are not forced into them. Consider the pattern of choices among federal retirees, many of whom are covered by Medicare as well. In a recent presentation on FEHBP for the National Academy of Social Insurance, Dr. Kenneth Thorpe and Dr. Curtis Florence, found that 83.3 percent of single retirees chose fee for service plans, while only 16.7 percent chose HMOs; for retired couples, 84.2 percent chose fee for service plans, while 15.8 percent chose HMOs.

Paradoxically, the pluralistic system of competing private plans in the FEHBP is operationally simpler for enrollees than the current Medicare program. Unlike the overwhelming majority of Medicare beneficiaries, Federal workers do not have to go outside of the system to buy supplemental coverage for drugs and catastrophic protection, and pay two premiums for two different plans. Medicare beneficiaries, unlike enrollees in the FEHBP, will end up spending roughly half of their health bills in out of pocket costs.

• Rational Financing. While the government spends about $220 billion for the Medicare program, covering almost 40 million retirees, the same government spends about $20 billion for the FEHBP, covering 9 million persons. But FEHBP is a program with a more rational payment system, a form of premium support for individuals and families, and a richer, more progressive and more varied health benefits package than Medicare. Under current law, the government pays 75 percent of the cost of any plan up to a maximum amount, set by formula. For 2001, that amount is up to $2250 for single individuals or $5090 for families. If individuals or families want to buy a more expensive plan, they can, but they will pay more for the richer plan. If they want to buy a less expensive plan, they can do that also. It's their choice.

• Less Bureaucracy, More information, and Higher Satisfaction. Unlike Medicare, which spells out in detail what benefits, treatments or procedures are to be covered, and what prices is to be paid for each medical service, the FEHBP is far less bureaucratic. Within the framework of annual negotiations, private plans present their combinations of benefits and premiums and co-payments to the federal workforce. Plans only do well when they sell a package of benefits at a price people want. Within statutory requirements and OPM approval, plan benefit packages differ, and so do their premiums, co-payments, co-insurance and deductibles. The government does not make everybody pay the same for the same package of benefits. Persons can enroll in any plan they wish; they have access to solid information, not only from the federal government, but also from a variety of private sector sources beyond the plans themselves.

Not surprisingly, levels of consumer satisfaction in the FEHBP are high. According to a 1997 survey of FEHBP policy holders who rated their plans as good, very good or excellent, 87 percent of fee for service policyholders described their plans this way, but 84 percent of HMO enrollees also did so. Not surprisingly, also, enrollees tend to stick with their plans. Based on previous experience, it is likely that no more than 5 percent of FEHBP enrollees will change their plans in a typical year. They pick plans they like, and tend to stay with them, as long as their plans perform on the market basis of price, quality and performance.

HOW SYSTEMIC CHANGE CAN LEAD TO REGULATORY RELIEF

At least for new retirees, there is no reason why Congress could not improve upon the record of the FEHBP and create a superior system for America's senior citizens, largely free of the regulatory complexities that trouble the current Medicare program. At the same time, recognizing there are significant differences between the Medicare population and the current federal workforce, the Congress would want to make sure that the transition to such a system should be undertaken carefully. In the creation of such a system, Congress should consider taking the following steps:

1. Make sure that the newly created administrative agency that oversees a reformed Medicare program- whether it is an independent board or an agency of the Executive branch of the federal government - functions in a fashion broadly similar to the Office of Personnel Management, which administers the FEHBP. The agency should negotiate rates and benefits on behalf of retirees; guarantee that plans offer the statutorily required benefits package; make sure that plans meet fiscal solvency requirements; make sure that plans comply with any statutorily prescribed underwriting rules, including guaranteed issue or renewability requirements; make sure that plans meet consumer protection requirements, including protections against fraud and misleading advertising, and ensure that competing plans provide plan information in plain English. For the FEHBP, OPM performs these functions today, and acts as a referee in setting and enforcing the ground rules among plans. Competing plans themselves do not have to wrestle with an overly burdensome regulatory system in complying with this consumer protection regime.

If Congress should decide to adopt a new competitive system, Congress may wish to protect the system itself from regulatory erosion. Regulatory creep can undermine legislative intent. In order to prevent the devolution of a competitive system into a powerful regulatory regime like that administered today by HCFA, Congress should consider enacting statutory prohibitions against any such agency from imposing government fee schedules, price controls, or premium caps on plans or providers participating in the new competitive system. Moreover, the Congress should make it statutorily clear that practice guidelines on doctors and hospitals, the adoption of quality standards, or the provision of lawful benefits or medical procedures that private plans may offer, over and above any statutorily required benefits package, are issues to be resolved in the competitive private market.

2. Promote Plan Flexibility in Benefit Setting. There are a variety of ways to do this. First, Congress could adopt the model that currently exists in the FEHBP. The Office of Personnel Management (OPM) sends out a call letter in the Spring of each year, outlining what it wants to see included in the plan benefit submission for the coming Fall "Open Season", when federal workers and retirees make their plan choices. OPM often specifies what benefit additions it would like to see in the plan submissions. And these plan submissions are the subject of sensitive and confidential negotiations between the representatives of the private plans and OPM officials during the summer of each year.

While OPM has broad authority to negotiate rates and benefits for each year, OPM is governed by specific statutory requirement in Title V of the United States Code that spells out the categories of benefits-such as physician and hospital services- that must be included by law in private plan offering. The law does not specify, however, the precise level of benefit, the duration of medical treatments or procedures, or the mix of premiums, co-payments, coinsurance and deductibles. All of these items are subject to negotiation, and OPM historically, has been flexible on these matters. In creating a new competitive system, instead of setting forth detailed benefits in legislation, Congress could replicate the FEHBP model, and confine itself to setting forth the broad categories of benefits, including catastrophic and prescription drug coverage that private plans competing in the new system must offer.

There are other possible options. Congress could set forth a core package of benefits that must be required, say, based on the current Medicare benefits package, with a further requirement for catastrophic and prescription drug coverage. But then, Congress could authorize the new administrative agency to allow the plans to offer the actuarial equivalent of that benefits package, with a differing mix of medical treatments or a different combination of benefits, co-payments or, deductibles. Congress could also authorize the new administrative agency to accept automatically,( assuming the inclusion of catastrophic or prescription drug coverage), a new retiree's employment based plan as an approved plan in the new competitive system, thus allowing workers to take their state or ERISA certified employer based plans with them into retirement as their primary coverage and get a government contribution to offset its cost, assuming that the employer would also be amenable to such an arrangement.

3. Authorize sophisticated information collection. Before entering into negotiations with private plans, the new administrative agency should conduct regular surveys among enrollees to get a clearer idea of what Medicare patients want in their insurance packages. With the coming eligibility of the 77 million strong baby boom generation for Medicare coverage, there is likely to be a rich diversity of demand for new and increasingly varied medical services. The new administrative agency should take advantage of sophisticated information technology to assess more accurately the precise nature of this demand, discerning what, precisely, individual enrollees want in terms of access to physicians and specialists, different types of coverage, and different types of benefits and different levels of premium payment and co-payment. This would help the officials to negotiate solid benefits on behalf of retirees at an affordable price. These information programs are already coming to fruition in the private sector. Just as they can be of immense value to employers in fashioning their own health insurance offerings, they could also be invaluable to a new government agency administering a pluralistic system of competing private plans for senior citizens. In this new environment, consumer based information would be the touchstone of all administration decision-making; and persuasion and friendly negotiation would replace regulation.

4. Ensure a smooth transition to a new competitive system by phasing it in, allowing plenty of time for mid-course corrections, and enabling private plans to adjust to the enrollment of new retirees. If there is any lesson that could be drawn from the damaged "Medicare+Choice" experiment, it is the crucial need for a well planned transition. There should be a high level of predictability for private plans, who must develop business plans to accommodate the changes in the system, without the fear that what they are attempting to do will be undercut by precipitous changes in federal regulatory policy. Perhaps the best way to accomplish this objective is to make sure that any new competitive system would be open only to new retirees, allowing it to grow on a year by year bases, and enabling the market to respond and mature. If, after a few years, when the system is up and running, the inevitable wrinkles have been ironed out, the Congress could open the new system up to enrollees in the traditional Medicare program.

5. Stop overloading HCFA. If Congress does create a new competitive system, HCFA should not be tasked with administering it. Given the culture of HCFA as a regulatory agency, it is not in any case the best candidate for partnering with private firms and administering a new market driven system. HCFA should be confined to administering the traditional Medicare program, and given the managerial flexibility to compete with private plan options for the allegiance of retirees. Congress should also consider creating alternative managerial structures for the administration of Medicaid, SCHIP and enforcement responsibilities under the Health Insurance Portability and Accountability Act.

A final thought. Reforming the Medicare program will be technically difficult, particularly in developing a transition to a new competitive system, and it will be politically challenging. But the alternative is to continue to manage Medicare through an increasingly complex body of statutory law, expanded judicial decision-making , and increasingly detailed regulation. Meanwhile, Medicare will face an unprecedented demand for medical services within this decade from an increasingly well educated, diverse and rapidly growing retiree population. Insisting on the status quo, and nourishing the inevitable regulatory growth of a fundamentally unchanged Medicare program could prove even more difficult and politically challenging.

Thank you.