June 13, 2013

Bryan R. Lawrence is founder of Oakcliff Capital, a New York-based investment partnership.

The 2013 Medicare Trustees Report had some good news. Costs per beneficiary grew just 0.7 percent in 2012, down from a 5.4 percent annual average since 1990. This is the third year of slow growth, and if the trend continues, our national finances will dramatically improve.

But the reasons for the slow growth are uncertain, and the trustees left their projection of annual future growth in costs per beneficiary unchanged at 4.3 percent. And that is the optimistic scenario: For the fourth straight year, the report included an appendix, prepared by Medicare’s staff, that outlines alternative projections in which costs grow faster.

Given the politics of Medicare and its phantom trust fund, it’s not surprising that both projections assume the same growth in the volume of health care consumed per beneficiary. The difference depends on the effectiveness of future price reductions that Congress has legislated.

The Medicare staff, backed by some of the program’s trustees, laid out its belief that the price reductions will not work: The impact on taxpayers would be $10 trillion in today’s dollars or tomorrow’s income taxes. So it makes sense to read the appendix.

The price reductions take two forms. The first is the physician reimbursement cuts required by the Balanced Budget Act of 1997. These have been overridden by Congress every year since 2003; at this point, they would require a 25 percent cut to physician fees. The trustees call it a “virtual certainty” that Congress will continue to override these cuts.

The second is the Affordable Care Act’s requirement that most other Medicare reimbursement rates be reduced by 1.1 percent annually. Because U.S. productivity growth has averaged 1.1 percent historically, the legislation assumes that health-care providers will achieve future 1.1 percent productivity growth and that they can be forced to lower their prices by that amount without reducing the volume or quality of care they provide to seniors.

But, Medicare’s staff argued, there has been no productivity growth in U.S. health care for decades. The staff cited a study showing that productivity in ambulatory care, hospitals and nursing homes declined 0.7 percent to 0.9 percent annually from 1987 through 2006, and there has been zero growth elsewhere. Getting a hip replacement or a routine checkup requires as much labor and capital as it did 30 years ago.

Worse, despite the lower reimbursement prices that Medicare pays for health care compared with private insurance (detailed in Steven Brill’s excellent reporting), many health-care providers respond by increasing the volume of care they provide. A 2007 analysis by the Congressional Budget Office found that between 1997 and 2005, Medicare reduced prices paid to doctors by 5 percent but that doctors increased the volume of care per beneficiary by 39 percent.

Finally, if the price reductions fail, the Affordable Care Act created an Independent Payment Advisory Board (IPAB) to decide how to control costs in some unspecified way. The Medicare report says this will be “challenging,” presumably because Congress has so routinely overridden its own Balanced Budget Act cost controls.

Boiled down, at least some of Medicare’s trustees and staff think that the Affordable Care Act assumes four unlikely things: Health-care providers will begin to deliver productivity growth that they have not achieved for decades; they will give all of the benefit to the government; they will not respond to lower prices by increasing volumes; and the IPAB will not be overridden by a future Congress.

It’s almost like the mad queen from “Through the Looking Glass,” who could believe six impossible things before breakfast.

When Medicare staffers consulted outside experts, all said that the price reductions would fail to reduce costs, though at least one expressed optimism that the cuts would force health-care providers to abandon fee-for-service billing and design new ways to bill and deliver health care. The Affordable Care Act calls for several pilot programs to experiment with alternatives to fee-for-service, including accountable care organizations and bundled payments. But, the trustees reported, “The ability of new delivery and payment methods to lower cost growth rates is uncertain at this time, since specific changes have not yet been designed, tested or evaluated.”

Those programs may yet work. But bad accounting and decades of politicians promising to protect “trust funds” have made discussion of controlling volumes politically difficult, even if the objective is higher-quality care.

After the trustees’ report was published, many politicians and journalists celebrated its two-year extension of Medicare’s trust fund. But that solvency is misleading. The trust fund has $288 billion — or just 1 percent of the $27.3 trillion cost in today’s dollars or tomorrow’s taxes of Medicare’s promises, even assuming the price reductions succeed.

Every other developed country has a health-care system that delivers better care for less cost. All have tackled the politics of managing volume as well as price. Despite the good news on recent costs, Medicare’s own report argues that we need to do this work as well.