The Spillover Effect of Medicare FFS on MA Negotiations

By Jeremy Kreisberg

The Congressional Budget Office (CBO) recently released an assessment of two illustrative versions of premium support for Medicare.  The report is interesting for many reasons, but I want to focus on one issue that Austin Frakt at The Incidental Economist raised.

Among the assumptions in the report, CBO “estimate[d] that in most counties the percentage of beneficiaries enrolled in the [Medicare Fee-For-Service (FFS)] program would decline once either premium support option took effect. . . . [T]he reduced market share of the FFS program would tend to boost the rates that private insurers paid to health care providers and thereby lead them to raise their bids” (pg. 39).

In a very thoughtful post, Professor Frakt questioned this assumption:

I read the details in the report that follow, but they didn’t help me with my fundamental objection. There’s a lot of verbiage about the (non-Medicare Advantage (MA)) commercial market paying higher prices than MA or FFS. The idea seems to be that Medicare private plans would tend to resemble the commercial market, if not for FFS. Hence, prices would go up if FFS became less of a threat, as it would under premium support.

This may be true, but not enough was said about why. The commercial market and the Medicare one serve different consumers, are challenged by different competitors, and are constrained by different regulations. They are different markets. Why should prices in one have any relation to those in the other?

I agree with Professor Frakt that there is no easy answer here, but I’m a bit more confident that CBO has a sound theoretical justification for its assumption.  After the jump, I’ll explain what I perceive as CBO’s theoretical justification, and I’ll note one interesting application of CBO’s reasoning to another controversial policy proposal.

As CBO and Professor Frakt both note, payment rates to providers through Medicare Advantage (MA) plans are lower for the same services than payment rates to providers through the under-65 commercial market.  Although CBO admits that “[t]he exact cause of the difference is not known” (pg. 39), they argue that the price differential is associated with the presence of Medicare Fee-For-Service (FFS) in the over-65 market (see pgs. 39-40).

The basic (though necessarily incomplete) story is as follows: FFS sets prices that are relatively low in the over-65 market.  These prices dominate the market because FFS dominates the over-65 market.  In order to compete with FFS, MA plans demand that providers offer rates that are similar to the rates set by FFS, and providers are generally willing to do so in order to avoid losing access to MA enrollees and to secure slightly higher prices than they would through FFS.  Indeed, as CBO notes, “the rates paid for [MA] enrollees are similar to or slightly above those that Medicare pays for FFS patients’ care” (pg. 39).  What changes then under premium support?  Well, the market share of FFS presumably would diminish.  And in those regions where FFS no longer sets the dominant rates, private plans will face similar pressures to those faced by insurers in the under-65 commercial market — specifically, pressures to succumb to higher payment rates from those providers on which potential enrollees depend.

If this story is correct, it seems that CBO’s model supports the following (perhaps counter-intuitive) reasoning: when an insurer with low, administered prices (FFS) loses market share, other insurers (MA plans) pay higher provider rates because they are able to use those low, administered prices as a bargaining tool with providers to a lesser extent.  But is the corollary also true? If a plan with low, administered prices gains market share, will other insurers pay lower provider rates because they are able to use those low, administered prices as a bargaining tool with providers to a greater extent?

Well, consider the implications of applying the corollary reasoning to a public option in the under-65 market that sets relatively low prices.  If the corollary reasoning is correct, then it seems that it would be reasonable to assume that a public option with significant market share and low, administered prices could impose downward pressure on provider rates in the under-65 private market.  Of course, this idea depends on several factors, including the competition among providers in each region, the public option’s market share, and the ability of the public option to attract providers with low, administered prices.  But the question is interesting nonetheless: should CBO’s reasoning regarding the effects of premium support on provider rates in the over-65 private market apply to the effects of a public option on provider rates in the under-65 private market?

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