Medicare Reform

I’d like to talk about the President’s new Medicare plan, but (from CNN) there’s little in the way of details.

In a major concession to congressional Republicans, Bush did not propose a specific [Medicare Reform] bill, but instead left the details to Congress. Republicans had warned the White House that to commit to specifics at this stage was too politically risky.

That’s a bold move.

On a more serious note, if the drug benefit is made optional, so that seniors can choose either (a) Traditional Medicare without prescription coverage or (b) Managed Medicare with prescription coverage, then seniors will self-select into the plan that is in their best interests. What this means in practical terms is that seniors who need a lot of very expensive drugs will disproportionately choose the second option. This implies that the average cost of prescriptions for seniors who opt (“self-select”) for such coverage will exceed the average cost of prescriptions for Medicare enrollees in the over-65 population. Anticipating this, private firms will have to price this factor into their plan or refuse to participate. This has already emerged as an issue in the “Medicare+Choice” managed Medicare program–many private HMOs rushed to join the new program in 1997 and 1998, only to begin withdrawing over the next few years, citing insufficient premiums from the government.

The general lesson is that people will select into the plan that gives them the greatest benefit. Generally (but not always) a greater benefit comes at greater cost. Don’t be surprised if two things happen. First, the cost of prescription coverage will exceed expectations and second, the savings from letting seniors move into managed care will fall short of expectations. Sure, part of this will be political opportunism (what program isn’t overbudget?), but part will be failure to account for adverse selection.


P.S. Another way to think of adverse selection is as follows: imagine that the cost estimates of adding a Managed Medicare with drug coverage would be accurate if seniors were randomly assigned to the new program or to the traditional one. The actual costs will be higher than this amount because seniors who need a lot of drugs will select the drug coverage option, while seniors who need a lot of surgery will select the traditional option.