A central question in the US debate over privatized Medicare is whether increased government contributions to private plans generate lower premiums for consumers or higher profits for producers. This research finds that insurance companies pass through 45% of higher payments in lower premiums and an additional 9% in more generous benefits for those who enrol in Medicare Advantage. Since the findings also suggest that the less than full pass-through is a result of insurer market power, efforts to make markets more competitive may be key to increasing the pass-through to consumers.
Medicare is the second largest social insurance program in the United States and the primary source of health insurance for the elderly. Medicare beneficiaries can choose to receive benefits through the traditional Medicare fee-for-service system or to enroll in private plans, which tend to offer a narrower network of healthcare providers in exchange for better (lower) cost sharing.
Private plans receive a capitation subsidy to take on Medicare beneficiaries, and may charge beneficiaries a supplemental premium. Today, about 31% of Medicare beneficiaries and over $200 billion of Medicare spending flow to this private plan option, which is known as Medicare Advantage.
Proponents of larger government subsidies for private healthcare plans argue that they lead to lower premiums or more generous benefits for Medicare beneficiaries
An important policy lever – in discussions of both entitlement reform and healthcare efficiency – is the level of subsidies paid to these private Medicare Advantage plans to bear health risk and manage healthcare for seniors. These subsidies have been adjusted up and down many times over the past two decades, including most recently by the Affordable Care Act of 2010.Proponents of larger subsidies argue that they result in lower premiums or more generous benefits for Medicare beneficiaries. Opponents argue that they lead to large profits for insurance companies and healthcare providers, with few gains for patients.
At their core, these debates are about economic incidence: does increasing government subsidies to private Medicare Advantage plans benefit patients or producers – and in what proportion?
Changes to capitation payments provide a natural experiment
In our research, we examine the incidence of subsidies to private Medicare Advantage plans by studying a sharp change in these payments brought about by the 2000 Benefits Improvement and Protection Act (BIPA).
Medicare Advantage payments to private insurance companies vary at the county level. Prior to BIPA, payments were largely determined by historical traditional Medicare per capita expenditures in the county. BIPA reformed these payments by instituting a system of rural and urban payment floors that raised payments in many counties.
In urban counties, the floor was set at $525 per member per month, and in rural counties at $475 per member per month. About 72% of counties had payments below these floor levels, and so plans operating in these areas faced an immediate payment increase equal to the difference between their prior capitation level and the new floor.
For example, an urban county with a $450 payment in 2000 would receive a positive $75 shock in 2001. A rural county with a $450 payment in 2000 would receive a positive $25 shock in 2001. Figure 1 shows maps for urban and rural counties of how these increases played out geographically across the contiguous United States.
Figure 1: Effect of BIPA on county base payments
(A) Floor distance, rural counties
(B) Floor distance, urban counties
We show that Medicare Advantage capitation payments in the counties where these floors were binding were following the same trend as in places unaffected by the floors in the period before the payment reform, but they increased by an average of about $50 per month or 12% when BIPA was implemented. This provides us with a source of ‘difference-in-differences’ variation in capitation payments.
We trace out the effects on outcomes such as supplemental premiums seniors paid for the Medicare Advantage plans and benefit generosity of these plans for counties that received a payment boost in 2001 compared to those that did not. We also study the degree to which the size of the effects on premiums and benefit generosity varies with the size of the increase in payments among counties receiving a boost in payments.
Pass-through to beneficiaries: 54 cents on the dollar
Figure 2 displays what happens to supplemental Medicare Advantage premiums when private insurance companies are paid more to take on a Medicare beneficiary. Although the typical county receiving an increased payment due to the newly implemented floors received several hundred dollars per beneficiary-year, we scale the analysis so that the figure displays the impact of one dollar in increased capitation payments.
Figure 2: Premium pass-through: Impact of $1 increase in monthly payments
The dashed horizontal line at zero in Figure 2 indicates no pass-through and the dashed horizontal line at -1 indicates full pass-through. Full pass-through occurs when a dollar increase in payments translates one-for-one into a dollar decline in premiums. The capped vertical bars in the plot show 95% confidence intervals.
In the first year following implementation, mean premiums decline by 30 cents for each dollar increase in payments and level off at a decline of approximately 45 cents in the third year after the reform. It is important to note that there is no evidence of a trend in the period prior to BIPA, suggesting that our finding is not spuriously driven by pre-existing trends in premiums across affected and unaffected counties.
In addition to lowering premiums, plans may have responded to the increased payments by raising the generosity of their coverage (benefits pass-through). We find some evidence of this: the increase in payments leads to a decline in average personal physician and specialist co-payments. These declines are highly statistically significant but modest in economic magnitude.
To aggregate information on physician co-pays, dental, vision, hearing aids, and drug coverage benefits, we calculate the actuarial value of these benefits (what they cost the insurance company), and examine how this actuarial value changes for each dollar increase in a plan’s subsidy level. Using the same methods displayed in Figure 2, we find benefits pass-through of 9 cents on the dollar (marginally statistically significant).
The combined pass-through of lower premiums and more generous benefits to plan beneficiaries amounts to 54 cents on the dollar
Taken together, the premiums and benefits results for 2003 yield a combined pass-through estimate of 54 cents on the dollar.A natural question in this context is whether value was being passed through to consumers along some other dimensions that don’t show up in plan premiums or benefits schedules.
It appears not. For every Medicare Advantage plan, we can also observe self-reported plan evaluations of enrolled consumers. These survey data allow us to investigate changes in plan quality that might not be picked up by our analysis of plan characteristics. We do not find any improvement in plan evaluations that are not accounted for by the plan premiums and benefits that we measure.
Disentangling the effects of selection and market power
In the benchmark economic model, consumers would receive 100% of the increase in payments (full pass-through). Why then did consumers receive only half of the increase?
Theory suggests two possibilities: market power; and an adverse change in the customer pool. To evaluate the role of each, we develop a model that helps empirically to disentangle the two forces.
In a competitive environment without customer selection effects (or more broadly with constant marginal costs), any changes in payments to plans must pass through to consumers one-for-one. But if firms have market power, they may not face competitive pressure to pass through increased payments into lower premiums or more generous benefits.
The second possibility – a change in the customer pool – could also explain incomplete pass-through even if there is substantial competition in the Medicare Advantage market. If a plan that lowers its premiums attracts a more costly group of newly enrolled consumers, then it must increase its premiums to break even. This leads to less than complete pass-through even in the absence of market power.
Using data on costs for fee-for-service Medicare beneficiaries, our estimates indicate there is limited customer selection into Medicare Advantage on the margin we study. Within our theoretical framework, the estimates imply that attracting more costly customers would reduce pass-through to 85% (in a perfectly competitive market). In other words, of the combined 46 cents in payments that is not passed through to beneficiaries, customer selection accounts for 15 cents or about a third of the shortfall.
The phenomenon remaining to explain the low pass-through is market power. We corroborate this idea with an analysis that splits the sample according to insurer concentration as measured by insurance companies’ market share in 2000 (the year before the policy change we study).
Premium pass-through rates are 74% in the most competitive markets compared with 13% in the markets with the least competition
Figure 3 shows estimates of pass-through into premiums for different levels of competition. Panel A splits the sample by the county-level Herfindahl- Hirschman Index for insurance companies in 2000. This index is high when one or two firms dominate a market, with the highest tercile corresponding to the most concentrated markets and the lowest tercile corresponding to the markets with the least insurer market power. Panel B splits the sample by whether the county had one, two, or three or more separate Medicare Advantage insurance companies in 2000.The regression specifications used to construct Figure 3 are identical to those used to construct the baseline pass-through plot in Figure 2, applied to each sub-sample. Figure 3 shows premium pass-through rates of 74% in the most competitive markets compared with 13% in the markets with the least competition.
Figure 3: Pass-through and market concentration
(A) Insurer HHI
(B) Insurer count
Implications
Delivery of publicly funded healthcare in the United States has become increasingly privatized over the past 25 years, with Medicare, Medicaid, and the Affordable Care Act exchanges adopting managed competition to varying degrees.
Although evaluating the merits of specific policy proposals is outside the scope of our analysis, our estimates indicate that efforts to make insurance markets more competitive may be key to increasing the pass-through of payments to consumers in such settings.
This article summarizes ‘Do Larger Health Insurance Subsidies Benefit Patients or Producers? Evidence from Medicare Advantage’ by Marika Cabral (University of Texas at Austin), Michael Geruso (University of Texas at Austin) and Neale Mahoney (University of Chicago Booth School of Business), which is forthcoming in the American Economic Review.
