Generations | Spring 2005 - Journal of the American Society on Aging

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Spring 2005
Featured Article

Confronting the Rising Costs of
Healthcare in Medicare and Medicaid

By Marilyn Moon

It has become trendy to argue that the growth in spending that has occurred in the Medicare and, in particular, Medicaid programs is out of control and needs to be reined in. But these programs should not be viewed as separate from the rest of the healthcare system simply because they are run through the public sector. In fact, the public and private health sectors are integrally related, and change in one area will be felt elsewhere. Moreover, some of the changes necessary to slow the growth of healthcare spending--or at least to ensure that society is investing wisely in these expenses--ought to occur throughout our healthcare system. Ultimately what matters is not the "appropriate" size of healthcare spending in the public sector, but the appropriate level of spending on healthcare for society as a whole.

In practice, it is easier to examine Medicare and the issues surrounding that program than Medicaid because of the vast differences across states in the shared state and federal Medicaid program. Thus, much of this article does focus on Medicare, but many of the same issues apply to Medicaid. Where appropriate, some of the particular complications arising from Medicaid will be raised.

Medicare and the Healthcare System

The Medicare program has always been closely related to the overall system of insuring care in the United States. In fact, one of the major goals of Medicare was to assure individuals access to mainstream medical care. The rules established to govern Medicare did little to disrupt or change the way healthcare was practiced or financed in the United States. Claims processing was structured to resemble the process found in the private sector and was to be handled by private contractors. Medicare statutes specifically assured free choice of provider and no interference in the routine practice of medicine. Payment rates were also designed to resemble those in the private sector, both in the mechanics and the level of payment.

After a few years, pressures on Medicare to hold the line on the growth in costs led to an effort to restrain price increases and eventually to reform the way in which payments are made. For example, since the reforms, Medicare payments to hospitals are based on paying for specific costs or are made on a per diem basis, rather than paying for the entire hospital stay, as was originally the case. Other insurers have since copied a number of the innovations in payment systems developed by Medicare. Private insurers have also adopted Medicare's decisions about coverage rather than establishing their own decision-making process. Thus, in many ways, Medicare has become a leader in creating norms for the healthcare system rather than merely being a follower.

And, over time, as Medicare increased in size and importance to the healthcare system, a new concern arose--that those in charge of this public program needed to be aware that changes in Medicare would affect the healthcare system as a whole. The level of payments to providers of care under Medicare, for example, should maintain a reasonable balance with the level of payments from private insurers. In this way, doctors and other healthcare providers would continue to treat both Medicare and privately insured patients. Indeed, the Medicaid program has occasionally been so out of step with private-insurer payments that access to care became a problem. At these times, Medicaid payments have usually been ratcheted upward to at least guarantee its beneficiaries some access to care. Much of Medicaid's growth is a result of instances in which it has expanded coverage--often to pick up coverage of people priced out of the private sector. A recent study of Medicaid found that payment rates keep the program's spending lower than the private insurance sector (Hadley and Holahan, 2003 / 2004 ).

Increases in Healthcare Costs

The problems driving Medicare costs upward are not unique to the public sector, but rather are found throughout the nation's healthcare system. The crisis of rising healthcare costs affects all payers: individuals, businesses, and governments. And just as Medicare is influenced by the overall healthcare system, the opposite is true as well. Although Medicare has been a leader in experimenting with options for curbing the increase in costs of care, both from rising prices and from greater use of services, costs continue to rise.

Rising prices. During the 1970 s, healthcare prices rose rapidly but at about the same rate as all prices in the economy. In the 1980 s, however, the general rise in consumer prices slowed, whereas growth in healthcare prices remained high. After 1980 , inflation in the price of healthcare occurred at rates substantially higher than those for inflation in the overall index. Between 1980 and the end of 2003 , all consumer prices except for healthcare grew 132 percent, whereas the CPI for healthcare grew 320 percent (U.S. Bureau of Labor Statistics, 2005 ). Even in the late 1990 s when medical care prices began to moderate, they still remained well above prices for other goods and services.

What caused this inflation in healthcare prices during the two decades in which the rate of growth of other prices slowed substantially? Some economists point to the fact that healthcare is heavily service oriented, with rising wages translating directly into rising prices. Productivity does not rise much in this sector of the economy, making it difficult to find ways to cut costs per service. But if a service orientation were the culprit, the problem of excessive growth in rates of price increases should exist for all types of service industries. Instead, a focus on only the service sector reveals that the differential between medical services and other services remains large: a 339 -percent growth in the price of medical services compared to a 165 -percent growth for all other services.

Nor is it possible to blame inflation in healthcare prices on strong demand for scarce services. The supply of physicians, for example, continued its rapid growth through the 1970 s and 1980 s. In 1970 the number of active physicians per 10,000 population stood at 15.6 . By 1988 , the number was 23.3 (National Center for Health Statistics [NCHS], 1991 ). This increase in the supply of physicians did not, however, lower their incomes, which rose an average of 8.6 percent per year from 1979 to 1988 . In 2000 , physicians per 10,000 population stood at 27.8 (NCHS, 2002 ). Further, hospitals operated at much less than capacity throughout the 1980 s, with occupancy rates averaging about 64 percent in 1993 (American Hospital Association [AHA], 1995 ). In 2001 , occupancy rates were up slightly, to 66.7 percent (NCHS , 2002 ).

So what is the explanation for rising healthcare prices? Much of it undoubtedly rests with the fact that for many years, the price structure of the healthcare industry did not come under heavy scrutiny. Users of healthcare are typically not the payers; usually a "third party" such as an insurance company or the government pays for the care. Insured people do not have to choose whom to see or what to use on the basis of the prices charged to the same degree as with the purchases of other goods and services. Moreover, and probably even more important, even when the patient is paying directly, people facing a medical crisis are unlikely to shop around for the least expensive care or to question the need for various services. In short, the nature of healthcare goods and services does not foster price competition. Though many older people lack comprehensive drug insurance, for example, they nonetheless continue to consume drugs--and to pay high prices for them. Thus, while the existence of third-party payers is indeed a factor in healthcare prices, it is not the only one.

As a public program, Medicare came under pressure to hold the line on prices in the 1980s--earlier than other payers. Many private payers finally began to take note in the 1990s--a period of considerable slowdown in price increases as insurers sought discounts in prices from providers of care. Once again, however, insurers face concerns about rising prices as providers of services have begun to rebel against years of low price growth.

Medicaid, on the other hand, has had even more price restrictions, resulting in very low payments for providers of care in many states. In fact, the prices in some places are so low that Medicaid spending is controlled not only by the program paying very little per service, but also by the program paying for fewer services, since many doctors and other providers decline to take Medicaid patients.

Use of services. The use of healthcare services has also continued to increase steadily. Indeed, increased use contributes more to higher healthcare spending than do price increases. Higher use occurs not just in terms of overall numbers of visits or treatments but in the type and complexity of healthcare services (often referred to as "intensity"). To some extent, this increased intensity is related to new technology that has given us tools such as computerized tomography (CT) scans, magnetic resonance imagers (MRIs), and procedures such as endoscopies and arthroscopies. Furthermore, expenditure for these new tools and procedures tends to occur, not as replacement for expenditure on older technologies and methods, but rather in addition to it. For example, people may now receive X-rays, CT scans, and MRIs to diagnose a problem, whereas before only X-rays were available.

New, less invasive tests and procedures have improved diagnosis and treatment for many Americans—and increased the frequency with which tests and procedures are used. For example, between 1999 and 2002 , imaging services paid for under the physician fee schedule grew by an average of 9 percent per capita as compared to a 3 percent growth for all fee-schedule services. And the fastest growing of these--MRIs, nuclear medicine, and CT--also tend to be very expensive (Winter, 2004 ). Some argue that these services are overused, when less advanced tests or fewer alternative tests would be sufficient. But the average patient has little reason to resist use of these tools. And, not only are physicians paid well for these extra tests, but testing may reduce the physician time necessary for a diagnosis. And since low reimbursement keeps doctors from spending large amounts of time with their patients, increased reliance on formal tests makes even more sense. Thus, the system for both public and private payers works to encourage development--and use--of new technology.

Conduct of surgery and other technical procedures continues to grow, albeit in settings different from those used in the past. Many procedures such as cataract surgery are now done in freestanding surgical centers or even physicians' offices. While it is difficult to track exactly what is happening to surgical procedures because of these shifts in treatment settings, studies have found that, when combined, the numbers of inpatient and outpatient surgeries continued to increase from 1980 to 1995 . Performance of some surgeries switched almost entirely to outpatient settings while others continued to expand in the traditional inpatient setting (Kozak, McCarthy, and Pokras, 1999 ).

The improved success of procedures like hip replacements and cataract surgery means that outcomes have improved while the risks of surgeries have fallen. In such cases, higher rates of use would certainly be expected and appropriate. The value of these procedures to individuals has increased over time. And lowered risks mean that older or disabled patients are particularly more likely to benefit now. It is likely that some of the increase in use is a reflection of the services' greater value and also of beneficiaries choosing to consume more of them. This case has been argued persuasively by David Cutler ( 2004 ), who also claims that spending on new technology has been worth the expense because it has extended life and enhanced standards of living.

And what of the private sector? In the mid 1990 s, employers moved their workers into more restrictive managed-care plans in which use could be more actively controlled. Cost growth dropped substantially. But the backlash by consumers against such plans has led to less stringency in recent years--and accelerating premium costs (Strunk, Ginsburg, and Gabel, 2001 ). Thus, the private sector has not been particularly successful in holding down use of services, even with its reliance on managed care.

The problem, of course, is in determining what proportion of the overall increase in use is desirable and what proportion might indicate excessive or unnecessary care. Cataract surgery offers a good example. We do not know what share of its explosive growth has occurred because people with early cataracts are encouraged to obtain the operation before it is medically appropriate and what share reflects surgeries that truly improve the quality of life for patients.

Growth in Medicare as Compared to Other Payers

As compared to private insurance, Medicare has been relatively successful in holding the line on growth in healthcare costs in the 1980 s and 1990 s. This comparison is shown in Figure 1 , which indicates rates of growth in per capita spending in Medicare and private insurance from the national health expenditure accounts on a selected set of services between 1970 and 2000 (Boccuti and Moon, 2003 ). These services--hospital care, physician and other professional services, and vision and durable medical equipment--are those that are consistently covered by both Medicare and private insurance. Between 1985 and 1992 , Medicare spending had lower rates of growth--often considerably lower--than did spending by private insurance. While growth of spending by the private sector slowed in the mid 1990 s, that improvement seems to have been short-lived and associated with one-time savings as employers shifted their workers to managed-care plans.

Thus, a historical look at the data suggests that Medicare is not out of sync with the rest of the healthcare system. Indeed, the patterns in spending growth are very similar to and often below those of private insurance. This finding is particularly important given factors that could be expected to drive up the costs of care for the older population relative to the costs of care for others. As new technology becomes safer and more effective, its use is likely to expand faster among populations like Medicare beneficiaries, who include a disproportionate share of sicker and more frail beneficiaries.

Finding Ways to Hold Down Costs

Medicare (and Medicaid) cannot be successful in holding down costs over the long run if healthcare spending in general is escalating. As stated, the pressures driving costs upward come from all parts of the healthcare system. Although together Medicare and Medicaid command a substantial share of the healthcare market, they cannot, alone, fully control use or prices.

When one payer--even a large one--acts alone, the response by providers can be to "divide and conquer," pitting one part of the system against the other. One place to see this phenomenon clearly has been in states that have very low payment levels for the Medicaid program. Here, in a number of instances, providers created crises of access by refusing to treat Medicaid patients. Broader system reform is needed for any long-run solution to the "cost problem" of Medicare and Medicaid.

Expecting Medicare alone to carry this burden or to operate under a system unlike the rest of healthcare is unrealistic. Alternatively, the process in recent years by which Medicare is adjusted incrementally, with awareness of how it compares to the private sector, can continue, at least for the time being. This process will result in actions such as the 1997 Balanced Budget Act changes that cut Medicare payments substantially and created more restrictive rules, some of which were later modified to keep Medicare largely in line with other parts of the system. Most recently, Medicare payments to physicians were adjusted, in early 2003 and again in 2004 , to correct an error in the formula for setting payments, but even more important, because of fears that the rates were beginning to lag too far behind those of the private sector and would discourage physician participation in the program. The visibility of the Medicare system inevitably invites comparisons with payments and service use elsewhere.

Medicare's place in the healthcare system should be recognized. Medicare cannot depend upon cross-subsidies from other payers. Employers who help to subsidize insurance for their workers became much more demanding in the 1990 s, and, from any source, payment levels to providers of care are seldom generous. Further, because Medicare represents such a large share of the market in many areas, the program must offer reasonable levels of payment. That is, while the size of Medicare gives the program market clout, Medicare's size also increases the program's responsibility to the overall financial health of the healthcare system. Also at issue is how well Medicare can enforce certain changes if they are limited to just part of the healthcare system.

The application of practice guidelines or limits on ineffective treatments would also be substantially more effective if done for the whole population. Since such guidelines and limits will be most effective if they change the attitudes of both providers and patients, efforts to influence practice must be viewed as aimed at system-wide changes that would be made for valid medical reasons and not just as one public program's gimmick to hold down its own costs. Patients are more likely to accept constraints if they feel the constraints are being equitably applied and are based on evidence rather than simply singling out one group for second-class treatment. Moreover, because it may be easier to change the attitudes of younger, healthier individuals than those of the typical Medicare beneficiary, successful reforms must aim to change incentives for the healthcare population as a whole, not simply the Medicare population.

The absence of comprehensive healthcare-system reform does not mean that Medicare must proceed independent of the rest of the healthcare system. The employer-based insurance market is now aggressively searching for ways to cut costs, putting enormous pressure on healthcare providers to offer increasingly deep discounts. It is even possible that bold moves in this direction by employers, insurance companies, and managed-care organizations may effectively begin to change the way that care is delivered. However, patients themselves have also been effective at pushing back on restrictions on care delivery--for example, when managed care went overboard in the private sector in the 1990 s. Medicare must be vigilant in adapting for its own use any cost-saving innovations that may be introduced into the private sector, including any changes in the overall delivery of care that may result from aggressive cost-cutting by the private sector across the board.

Even in the absence of comprehensive system reform, coordination between the public and private sectors can at least ensure that the direction of change is consistent throughout the system--a consideration that is also essential in avoiding efforts to shift costs that do not necessarily save resources for society as a whole. One way to achieve such coordination may be by actively promoting better evidence on effectiveness and applying it to coverage decisions. The information is effectively a public good that should be broadly shared, and government is an appropriate source for such information.

Many of the remaining options for reducing the costs of Medicare over time are explicitly or implicitly aimed at shifting costs onto beneficiaries rather than at truly reducing healthcare spending. The direct ways in which that happens is through proposals for higher premiums or cost sharing, for example. Other options, such as raising the age of eligibility for Medicare or creating a voucher program with a set contribution to the costs of care coming from the government, are simply more subtle ways of achieving the shift of costs to beneficiaries. All of these options are effectively financing options in which the question of who should pay is answered without any specific acknowledgement that such a decision has been made. And the answer, of course, is, the beneficiary should pay. Such an approach does not work for Medicaid because it is very difficult to shift costs onto its beneficiaries, who are very poor; nonetheless, states use various means to limit eligibility.

A better way to answer the question of who should pay for healthcare is to do so directly in an honest discussion of the ability of various groups to support the costs of healthcare services that we as a society decide are necessary. Ultimately, treating the issue as if it were only a matter of limiting public spending allows us to avoid the broader debate that is crucial if this important concern is to be effectively addressed. 1

Marilyn Moon, Ph.D., is vice president and director, American Institutes for Research, Health Program, Silver Spring, Md.

Finding Ways to Hold Down Costs

The absence of comprehensive healthcare-system reform does not mean that Medicare must proceed independent of the rest of the healthcare system. The employer-based insurance market is now aggressively searching for ways to cut costs, putting enormous pressure on healthcare providers to offer increasingly deep discounts. It is even possible that bold moves in this direction by employers, insurance companies, and managed-care organizations may effectively begin to change the way that care is delivered. However, patients themselves have also been effective at pushing back on restrictions on care delivery—for example, when managed care went overboard in the private sector in the 1990 s. Medicare must be vigilant in adapting for its own use any cost-saving innovations that may be introduced into the private sector, including any changes in the overall delivery of care that may result from aggressive cost-cutting by the private sector across the board.

Marilyn Moon, Ph.D., is vice president and director, American Institutes for Research, Health Program, Silver Spring, Md.

References

American Hospital Association. 1995. Hospital Statistics, 1994 - 1995 Edition. Chicago: American Hospital Association.

Boccuti, C., and Moon, M. 2003. "Comparing Medicare and Private Insurance: Growth Rates in Spending Over Three Decades." Health Affairs 22 : 230 - 37 .

Clark, R., et al. 2004. The Economics of an Aging Society. Malden, Mass.: Blackwell Publishing.

Cutler, D. 2004. Your Money or Your Life: Strong Medicine for America's Health Care System. New York: Oxford University Press.

Hadley, J., and Holahan, J. 2003 / 2004 . "Is Health Care Spending Higher Under Medicaid or Private Insurance?" Inquiry 40 ( 4 ): 323 - 42 .

Kozak, L. J., McCarthy, E., and Pokras, R. 1999 . "Changing Patterns of Surgical Care in the United States, 1980 - 1995 ." Health Care Financing Review 21 (1): 31 - 49.

Moon, M. Forthcoming. Medicare: A Policy Primer. Washington, D.C.: Urban Institute Press.

National Center for Health Statistics. 2002. Health, United States, 2002 With Chartbook on Trends in the Health of Americans. Hyattsville, Md.

National Center for Health Statistics. 1991 . Health, United States, 1991 With Chartbook on Trends in the Health of Americans. Hyattsville, Md.

Strunk, B. C., Ginsburg, P. B., and Gabel, J. R. 2001 . "Tracking Health Care Costs." Health Affairs , Web Exclusive ( 2001 ), W 39 -W 50 .

U.S. Bureau of Labor Statistics. 2005 . "Most Requested Statistics: Consumer Price Index." (http://data.bls.gov/cgi-bin/surveymost?cu)

Table of Contents

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Confronting the Rising Costs of Healthcare in Medicare and Medicaid

References

Confronting the Rising Costs of
Healthcare in Medicare and Medicaid