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The Medicare Model By: Robert A. Book
The Heritage Foundation | Tuesday, July 28, 2009

One of the most hotly debated proposals in health care reform is the establishment of a new "public plan"--a health insurance program operated by the federal government and modeled on Medicare. In most variants of this idea, the public plan would "compete" with existing health plans currently offered by employers, in the individual insurance market, and/or in a new national health insurance exchange. President Barack Obama says that "a public health insurance option operating alongside private plans" would give Americans "a better range of choices, make the health care market more competitive, and keep insurance companies honest."

The Claims. Proponents of the public health plan idea claim that the high cost of American health care is caused by private insurance companies' expenditures on marketing, efforts to deny claims, high executive salaries,unrestrained pursuit of profit, and unwillingness to drive "hard bargains for reduced prices" from hospitals and physicians. They claim that the federal government's "bargaining power" allows Medicare--the nation's largest existing public health plan--to achieve lower costs and slower cost growth, and that the government could achieve similar results with a public plan for the non-elderly.

Proponents also claim that competition from such a public plan would reduce private-sector health care costs by forcing private insurers to either reduce costs to the supposedly lower public plan level or go out of business. Many even claim that, if the entire privately insured population were switched to a public plan, enough could be saved in administrative costs alone to pay for covering all Americans who are currently uninsured.

This rationale for creating a new program modeled on Medicare is based on four erroneous beliefs: (1) that, compared to private-sector health plans, Medicare provides comparable access to health care with slower cost growth; (2) that Medicare's administrative costs are lower; (3) that Medicare uses superior bargaining power to reduce health care costs without harm to patients; and (4) that public health plans are more innovative, whereas private health plans only follow the government's lead.

The Reality. All of these beliefs are demonstrably false. Contrary to the claims of public plan advocates:

  • Total per-beneficiary health care costs are growing faster for Medicare patients than for private insurance patients. Medicare's per-beneficiary costs appear to grow more slowlythan private plan costs only if one ignores the fact that Medicare is paying a rapidly shrinking share of its beneficiaries' total health care costs. Total per-beneficiary patient care costs are growing faster for Medicare than for private insurance. However, spending by the Medicare program is growing more slowly than spending by private insurance because much of the growth in health care costs for Medicare beneficiaries is offset by increased out-of-pocket spending and other sources of private-sector funding.
  • Medicare's per-beneficiary administrative costs are substantially higher than the administrative costs of private health plans. The illusion of lower Medicare administrative costs comes from expressing administrative costs as a percentage of total costs, including patient care. Medicare's per-person administrative costs are spread over a larger base of health care costs because its beneficiaries are by definition elderly, disabled, or end-stage renal disease patients.
  • Medicare has no "bargaining power." To the extent that Medicare pays health care providers lower prices than private plans, it is due to the government's regulatory power, not bargaining, and certainly not by reducing the actual costs of providing care. Lobbyists for physicians have persuaded Congress in each of the past seven years to block scheduled reductions in these prices that Medicare pays for physician services--and in six of those years to replace the reduction with an increase. This suggests that Medicare does not, in fact, have enough bargaining power to lower prices further.
  • Historically, public plans have more often been followers, not leaders, in health care delivery innovation. It is private-sector organizations that have introduced new quality-improvement methods and new customer services, as well as disease management and coverage of preventive care.

Other Dangers. The current Medicare program, which covers one-fifth of the American population, has unfunded future liabilities of over $36 trillion. A public plan with Medicare's essential characteristics that covered the entire population--or a significantly larger fraction of it--would not reduce costs and would be even more financially unsustainable.

Furthermore, any public plan would be driven by congressional interventions, bureaucratic processes, and lobbying rather than by incentives to deliver quality, efficient health care. This was evident with Fannie Mae and Freddie Mac: "public plan" mortgage companies that were established to "keep private lenders honest" and increase levels of home ownership. Driven by congressional interventions and policies at odds with economic reality, these public mortgage companies collapsed and threw the entire financial system into chaos. A "Freddie Doc" would produce similarly disastrous results.

No Cost Advantage to the Public Plan Concept. Despite the claims of proponents, the available evidence from the nation's largest and oldest public health care plan does not indicate that a new or expanded public plan modeled on Medicare could provide Americans with health care comparable to that offered by existing private plans, let alone at a lower cost. A public plan would be no better than the status quo and might well prove to be much worse than the "disease" it is intended to cure.

Americans clearly need health care reform, but a public plan is the wrong kind of reform. Contrary to the claims of the President and some Members of Congress, a public plan could not achieve cost savings or reduce the number of uninsured without substantially reducing the quality and access to health care that Americans currently enjoy.

Robert A. Book is a Senior Research Fellow in Health Economics at The Heritage Foundation's Center for Data Analysis.

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