How insurers flipped a Medicare pay cut into a pay raise

April 2, 2013

Monday afternoon was a really great time to be a health insurance plan.

Right before 4 p.m., the industry's stocks all skyrocketed upward. Humana, Aetna, Cigna, UnitedHealth—the companies represented in chart above— all saw big increases.

They did so with good reason: the Obama administration reversed a proposed 2.3 percent pay cut for private Medicare plans, replacing it with a 3.3 percent raise.

For health plans, this was a huge victory. As Citi analyst Carl McDonald put it in a Tuesday note to investors, this was "Armageddon averted."

"The rate adjustment," McDonald continues, "sends a pretty clear message that CMS has no interest in seeing major disruption in the Medicare Advantage program right now, quieting concerns about a post election desire to rein in enrollment and margins."

Medicare Advantage plans will still get a tiny haircut due to other changes the federal government proposed. The 2.3 percent pay cut that became a 3.3 percent raise was one among a few cuts that the Obama administration had proposed for 2014.

Cuts to Medicare Advantage plans mandated in the Affordable Care Act, for example, will still go forward.


Overall though, the cuts are way smaller than what the Obama administration initially proposed. McDonald at Citi estimates that Medicare Advantage plans will see a 2 percent rate reduction, compared to 7 percent to 8 percent that analysts predicted with the initial rates.

Wait, how exactly does a pay cut become a pay raise? When I asked Medicare acting administrator Marilyn Tavenner about the proposed pay cut, back in February, she said it was due to a slowdown in Medicare cost growths.

"Part of this is formula-driven and it goes back to the slowdown in costs," she said. "Part of it we can be open, part of it we’ll have to look at the formula for what the true costs have been."

Medicare costs haven't changed in the past two months—but two other things did.

First, political pressure ratcheted up. As my colleague Sandhya Somashekar reports, over 100 legislators pushed Medicare to reverse the cuts. America's Health Insurance Plans, which lobbies for the industry, aired television ads titled "Drastic" and "Too Much."

Second, Medicare changed how it thinks about the future costs of the program. For the first time ever, the agency assumed that Congress would pass a "doc-fix," to avert a double-digit pay cut for Medicare doctors.

This isn't exactly a wild assumption; for nearly a decade now, Congress has allotted extra funds to fill a gap between what federal law says Medicare doctors should get paid—and what the Medicare funding formula actually allots them.

Still, this was something that Medicare has never assumed before. It's projections have typically hewed to what the law looks like right now, making no assumptions about what legislators would do in the future.

In the document announcing the final rates, the Office of the Medicare Actuary objects to this change, noting that it differs from calculations in years prior: "It is in the Office’s professional judgment that, as in all past years, the determination should be based on current law, not an assumed alternative."

Assuming that Congress will bump up doctors pay totally changes the ballgame for forecasting how much the government needs to pay private Medicare plans. All of the sudden, Medicare needs to assume a 25 percent pay increase for providers—and that means Medicare Advantage plans need more money to pay those increased rates.

That, in a nutshell, is how a 2.3 percent pay cut becomes a 3.3 percent raise.

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Ezra Klein · April 2, 2013