Last week Congress cut benefits to Medicare recipients and liberal pundits applauded. Indeed, Paul Krugman said this was "Kennedy’s Big Day" and "the first major health care victory that Democrats have won in a long time." Of course, Krugman and the others who applauded this "victory" didn’t say that they were cutting Medicare benefits – even though that is exactly what they were doing – instead they framed the victory as one over privatization and waste. Here’s the story.

Medicare beneficiaries can enroll in Medicare’s fee for service plan or they can choose Medicare Advantage joining, for example, an HMO. In the latter case, Medicare pays the HMO a rate per enrollee and the HMO competes to obtain enrollees by offering them a package of benefits and premiums.

Now what you will be told about Medicare Advantage is that it is more expensive than traditional Medicare. Thus the CommonWealth Fund says:

Private Medicare Advantage (MA) plans were paid an

average 12.4% more per enrollee in 2005 compared with what the same

enrollees would have cost in the traditional Medicare fee-for-service

program…

That much is true. But why are MA programs more expensive? The answer, which one gets by innuendo and implication, is that Medicare Advantage programs are wasteful and the extra money is being pocketed by corporations.

The CommonWealth Fund says:

"…eliminating extra payments to private plans could save Medicare a projected $30 billion over five years." (italics added)

Paul Krugman says:

the fastest-growing type of Medicare Advantage plan, private

fee-for-service, costs taxpayers 17 percent more per beneficiary than

Medicare without the middleman. (italics added).

Robert Waldmann is least careful and in a comment on Tyler’s article on means testing says

Cowen doubts that expanding the public share of health insurance would

reduce costs. We have a test case medicare vs medicare advantage

accounts. They cost, on average 12% more per patient…

Thus the message is that traditional Medicare is cheaper because it eliminates the middleman, doesn’t involve private corporations, and is more efficient at lowering costs. None of this is true.

I’ll give you the full story in a minute but let me first point to one clue that something is amiss. According to all of the above "enrollment in these plans has been growing rapidly" (Krugman). Now why would so many Medicare beneficiaries opt out of low-cost, efficient Medicare and into high-cost, inefficient MA plans?

While you puzzle over the clue let’s cover the necessary background. Here is how the MA program pays a private provider (quoting the CBO).

Private plans that want to participate in the Medicare Advantage program must submit bids indicating the per capita payment for which they are willing to provide Medicare’s Part A (Hospital Insurance) and Part B (Supplementary Medical Insurance) benefits–and to take on the financial risk of doing so. The government compares those bids with county level benchmarks that are determined in advance through statutory rules. The benchmarks are the maximum payment the government will make for enrollees in private plans; in most cases the plans’ bids (and the resulting payments) are lower than the benchmarks…. If a plan’s bid is less than the benchmark, Medicare pays the plan its bid plus 75 percent of the amount by which the benchmark exceeds the bid.

So far you might think that Krugman et al. have a point. If the benchmarks are set too high and Medicare pays the plan its bid plus 75% of the amount by which the benchmark exceeds the bid then the plans could bid their costs and get extra payments. Now, I hope that many of you are thinking, What about competition? Good thinking! Indeed, if that was all there was to it, competition would push the bids below costs. But in fact to resolve our puzzle we need not rely on competition and economic theory because here is the kicker (quoting the CBO again, italics added):

If a plan’s bid is less than the benchmark, Medicare pays the plan its bid plus 75 percent of the amount by which the benchmark exceeds the bid. Such a plan must return that 75 percent to beneficiaries as additional benefits or as a rebate of their Part B or Part D premiums.

Now the solution to our puzzle becomes clear. Why do beneficiaries choose MA plans?

…because such plans provide additional benefits beyond those available within traditional Medicare, including coverage for services not covered by FFS Medicare (for instance, dental services) and cash rebates of premiums or reduced cost-sharing.

In fact, the CBO estimates that the vast bulk of the increased payments to private providers flow to enrollees who get better benefits and lower payments. Indeed, in the case of HMOs enrollees benefit twice – first because the benchmarks are higher and second because, contra Krugman et al., the HMOs actually have lower costs than traditional Medicare! Thus the CBO writes:

In contrast, payments to HMOs averaged 10 percent above FFS costs…On average, HMOs offered extra benefits and rebates equal to 13 percent of FFS costs; those additional benefits and rebates reflected the difference between the benchmark (which averaged 10 percent above FFS costs) and the plans’ bids (which averaged 3 percent below FFS costs).

That could be written more clearly but what they are saying is that Medicare pays HMOs 10 percent more than they would pay for an enrollee in traditional Medicare but the HMOs offer the enrollee 13 percent more worth of extra benefits and rebates. In other words, the HMOs pass on to the enrollee all of Medicare’s "extra payments" plus some. (Note that this is exactly what one would expect in a competitive market.)

Now, I am not saying that higher Medicare payments are a good idea. But I dislike the fact that politicians are being lauded for fighting "wasteful privatization" when what they are really doing is cutting medical benefits for the elderly.