Medicare Advantage – the Private Option

June 29, 2014
Posted by Jay Livingston

Healthcare stubbornly refuses to conform to conventional economic models, particularly the idea that competing private firms are more effective than government.  Medicare Advantage may be the latest example of privatization not working out the way it’s supposed to.

Medicare Advantage is part of George W. Bush’s  Medicare Modernization Act (MMA) of 2003.  Medicare, the original,  is a single-payer system; the government pays doctors. Medicare Advantage is the private option – the government pays money to insurance companies, who in turn sell insurance plans for seniors. 

The theory behind this privatization of Medicare was that it would bring more insurance companies into the market, and the competition among those companies would result in better and cheaper medical coverage.  Opponents of the MMA saw it as yet another instance of the Bush administration giving away money to business. 

Did the Medicare Advantage subsidies bring better results? We don’t have a randomized control study, but a provision of the MMA allows for a sort of natural experiment.  Counties in areas with a population of 250,000 or more got subsidies that were 10.5% greater than counties in areas under 250,000.  Three Wharton professors* compared the outcomes. 

One of the results comes right out of the Econ textbook: where subsidies were higher, more firms followed the money and entered the marketplace. They also enrolled more people.

The first key takeaway is that a firm’s decision to enter a market is highly responsive to how much the government pays. When the government pays more for private health insurance through Medicare, more insurers compete to offer that coverage.

But the important question is whether the money that brought companies into the marketplace went to cheaper and better medical care.  And if not, where did the money go?

Our findings indicate that we see more insurers enter and we see more people enroll, and we see more advertising expenditures. But we actually don’t see much better quality when you pay plans more. The question then naturally rises, “Where does the money seem to go?” And in a final empirical analysis, we try to see how much of it ripples through to profits of health insurers. And we see that a quite significant share of it does. [emphasis added].

This is not really surprising. For-profit firms want to make a profit. In theory (classical economic theory), they should make that profit by providing a better product. Unfortunately, that’s not what happened.

A second takeaway is that, at least given the many quality measures that we can look at, we don’t find a ton of evidence that paying plans substantially more leads to much better quality. . . .  We didn’t see a big improvement in quality. And we’re talking about billions of dollars in additional government spending as a result of this somewhat higher reimbursement in the places with a population of 250,000 or more.

Under Obamacare, reimbursements to Medicare Advantage will shrink. Reimbursments to Medicare Advantage have been 14% higher than those in the traditional Medicare, and Obama care aims to reduce that difference. Obama opponents have run scare ads, and of course the insurance companies have lobbied heavily against the reductions.  But according to the Wharton study, the reductions will have little impact on seniors.

there are a number of changes that will take effect over the next several years as a result of the Affordable Care Act, better known as Obamacare. Chief among them is a reduction in the generosity of reimbursement of Medicare Advantage plans… our evidence suggests that the costs of those reimbursement cuts for consumers might not be so great after all..


*Mark Duggan, Amanda Starc, and Boris Vabson, NBER paper “Who Benefits when the Government Pays More? Pass-Through in the Medicare Advantage.” The interview with Duggan is here

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