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What Paul Ryan's Critics Don't Know About Health Economics

A premium-support system would create the right incentives for cost cutting without putting undue burdens on seniors.
By Alain Enthoven

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Washington, Jun 3, 2011 | comments

It's clear that Medicare-spending growth must be curtailed and eventually limited to the growth rate of GDP—if not below. The big question now is how to do it. Unfortunately, the debate on Capitol Hill and in the media is too often fueled by partisan fear mongering instead of a thoughtful examination of the facts.

Health care in America is extremely wasteful. A 2005 report by the National Academy of Engineering and the Institute of Medicine found that 30-40 cents of every dollar spent on health care are spent on costs associated with "overuse, underuse, misuse, duplication, system failures, unnecessary repetition, poor communication, and inefficiency." Medicare is especially vulnerable to waste, fraud and abuse.

No amount of price cutting or central-government dictates will mitigate these problems. Their cure requires detailed local knowledge, incentives and fundamental organizational change so that curing them is in the interest of providers and patients.

At the root of the waste and excess is Medicare's open-ended fee-for-service system, which pays health-care providers for doing more and more costly services, whether or not they're in the patients' best interests. Last year's health-care reform legislation acknowledged that fundamental change is needed from the traditional fee-for-service model to a system in which doctors and hospitals team up to offer coordinated care and are held accountable for per-capita cost and quality. Hospitals and suppliers may participate in this Shared Savings Program by creating or joining an Accountable Care Organization (ACO).

Unfortunately, the incentives to form ACOs and to dramatically cut costs are far too weak and the regulations far too complicated. The rules alone for joining the Shared Savings Program number more than 400 pages, and to fully understand them is a daunting challenge for medical professionals. The program is voluntary, and, not surprisingly, it now appears that there will not be many takers.

In a recent letter to the administrator of the Centers for Medicare and Medicaid Services, the American Medical Group Association wrote: "On its face, [the rule to form an ACO] is overly prescriptive, operationally burdensome, and the incentives are too difficult to achieve to make this voluntary program attractive. . . . In a survey of AMGA members, 93 percent said they would not enroll as an ACO under the current regulatory framework."

A better way to encourage accountable care is the "premium-support" model proposed by House Budget Committee Chairman Paul Ryan, among others. This is a managed competition model in which government would make a defined contribution and beneficiaries would have a choice from a variety of health plans with no discrimination based on health status. Standard coverage contracts would make comparisons possible for ordinary people. Competition would drive health plans to innovate in ways that cut waste and improve quality. And the use of exchanges would drastically reduce marketing costs, so insurance companies would not be taking 20% off the top, as is currently the norm.

This is not "the end of Medicare," as some would have you believe. As Rep. Ryan wrote in these pages in April: "Medicare will provide increased assistance for lower-income beneficiaries and those with greater health risks. Reform that empowers individuals—with more help for the poor and the sick—will guarantee that Medicare can fulfill the promise of health security for America's seniors."

These are also not "vouchers" in which "seniors would, in effect, be handed a coupon and told to go find private coverage," as columnist Paul Krugman recently wrote in the New York Times. Under the Ryan plan, seniors would receive a menu of participating contractors to choose from. And because Medicare Administrative Contractors, the firms that pay Medicare claims, are already private, this is not exactly "privatizing Medicare" either.

The Ryan plan isn't perfect. It proposes that after 2021 the premium-support payments be indexed to the consumer price index, which grows at a lower rate than GDP. The feasibility of that proposal is debatable and negotiable. But instead of seeking common ground, Democrats immediately attacked the entire plan. We now face the kind of partisan brawl that absolutely turns off independent voters.

Personally, I think a growth rate as low as the consumer price index is probably unrealistic. But it is foolish to focus debate now on a formula that will not take effect until 2021. The premium-support payments in the next decade can be decided in the next decade, and reasonable people ought to sit down and work out a compromise.

A more pressing problem is that, in the face of unsustainable federal deficits, 10 years is too long to wait to start cutting costs. Congress should focus on implementing competition in Medicare sooner. The problem with just cutting hospital payments now is that hospitals will continue to shift costs onto private payers.

The 2010 health-care reform's Independent Payment Advisory Board is unlikely to be effective. Appointed by the president, 15 experts with no financial ties to the health-care industry are supposed to dream up cost-cutting ideas that would go into effect unless overridden by a supermajority in Congress. But the reality is that most waste identification and cutting is local. These 15 central planners are unlikely to do as good a job as hundreds of doctors and managers in local delivery systems working with incentives to improve value for money for their enrolled members.

Mr. Enthoven, a health economist who helped to design the premium-support concept 30 years ago, is a professor emeritus at the Graduate School of Business at Stanford.

View online at The Wall Street Journal

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