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Three ways Obama wants to cut Medicare

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In his State of the Union address, President Obama pointed to three ways he plans to reduce Medicare spending.

"We’ll reduce taxpayer subsidies to prescription drug companies and ask more from the wealthiest seniors," he said. "We’ll bring down costs by changing the way our government pays for Medicare, because our medical bills shouldn’t be based on the number of tests ordered or days spent in the hospital – they should be based on the quality of care that our seniors receive."

What does that mean? It essentially boils down to three policy proposals: Bringing Medicaid drug rebates to Medicare Part D, means-testing the Medicare program for higher-income seniors and moving toward pay-for-performance reimbursement methods. Let's break those down.

Right now, Medicaid gets a really good deal on prescription drugs: Manufacturers have to sell their prescriptions to the entitlement program at the very best price they offer private insurance plans or 23.1 percent lower than the average price. This has lead to big discounts for the program: The Office of the Inspector General at Health and Human Services estimates that this provision has reduced Medicaid spending on drugs by 45 percent.

Medicare added its prescription coverage option in 2006, Medicare Part D. Their drug procurement processes work differently: Each private Part D plan negotiates with a drug manufacturer to obtain their own, lower rates. There’s no set discount, however, like there is in Medicaid. The HHS Office of the Inspector General estimates that the Medicare Part D program gets a 19 percent discount on drugs, compared to the 45 percent discount that Medicaid negotiates. This is most important in how it applies to the dual eligibles, the low-income seniors who qualify for both Medicaid and Medicare. In the early 2000s, these 6 million or so patients got their drugs through the Medicaid program. That all changed when Medicare added Part D and its drug purchasing moved over into that new program. The dual eligibles tend to be some of the heaviest users of prescription drugs, with upward of $6,100 in medication costs annually. Now, their drugs are coming in at a higher price to the federal government. So what the White House is proposing here is essentially moving Medicare into a system where they purchase drugs at a specified, lower price. They estimate this would save $156 billion over 10 years.

Next up, means-testing for higher income seniors. Under current law, Medicare beneficiaries cover about 25 percent of the monthly premiums for Part B (which covers doctors) and 25.5 percent for Part D (which covers prescription drugs). The federal government foots the rest of the bill. As part of the Affordable Care Act, higher-income seniors are required to pay a bigger share of their health-care costs. This starts with seniors who earn more than $85,000 and gradually scales upward for higher-earning seniors, as you can see in this chart from the Kaiser Family Foundation.

Last up: Paying for quality. This policy is a bit less specific; there's no one way to pay hospitals for delivering higher quality care. You could hand out bonus payments to hospitals that meet certain quality metrics — or withhold dollars from those that don't. You can put a firm cap on how much you'll pay a health-care provider, incentivizing them to stay within a set budget. The Affordable Care Act already has a few policies like this. The law penalizes hospitals, for example, who have patients come back for a preventable readmission: A repeat hospital trip that was caused by the first visit to the doctor. As of last October, hospitals can now lose 1 percent of their Medicare reimbursement rates for these repeat visits.

The health-care law created Accountable Care Organizations, teams of doctors and hospitals who band together and accept a lump sum payment to take care of a given Medicare patient. Those who can deliver high quality health care for less will get to split the savings with the federal government.

There are ways to crank programs like these up: You could tether even more of hospitals' income to readmission rates, or put a greater part of a hospital budget's at risk in the ACO model. Those could be a few of the ideas that Obama is talking about when he mentions paying doctors for the quality of care they provide, rather than the quantity.