There has been a lot of discussion about President Obama’s proposed $716 billion “cut” to Medicare. The administration has explained that these “cuts” will not reduce services to Medicare beneficiaries but will instead largely come from reducing payments to providers over a ten-year period. These “cuts” refer to hospitals, home health care services, nursing homes and other such services seeing smaller increases in their payment rates from Medicare every year.
The $716 billion proposal begs a very important question: will these providers start rejecting Medicare patients if they begin receiving lower Medicare reimbursements? And as a result, is the projected $716 billion in savings a hopeless aspiration?
The Math and Myth of Productivity Gains
The reduction in payment rates is based on an expectation that providers can improve their productivity, thereby delivering the same services at a lower cost. The key underlying assumption is that health care can achieve similar productivity gains as the general economy.
The problem with this assumption is that history has shown that it is very difficult to show improvements in health care. In his testimony to the House Budget Committee, Richard Foster, Chief Actuary of the Centers for Medicare & Medicaid Services, pointed out that most of the health care sector has never achieved productivity gains at the rate of the general economy. In the specific case of hospitals, which account for a large portion of the anticipated $716 billion in savings, productivity between 1981 and 2005 was small or negligible.
The Squeeze from Rising costs and Lowered Payments
If providers are unable to achieve the anticipated productivity improvements, the gap between their revenues and costs will widen over time. Providers that largely rely on Medicare funding could see a significant impact to their bottom lines. Foster estimates that approximately 15% of providers would no longer be profitable due to the projected reduction in rates, all else being equal. In order to stay in business, some providers may therefore begin turning away Medicare patients altogether.
If providers threaten to drop Medicare patients, Foster believes that Medicare will have to make concessions with regards to the payment cuts. This would ultimately cut into some or all of the $716 billion in proposed savings.
The Significant Impact of the “Individual Mandate”
In reality, the payment reductions will not take place in a vacuum. Though providers will be negatively impacted by lower rates, these same providers will experience significant benefits due to the individual mandate. The individual mandate requires individuals who don’t have health insurance through their employer to purchase coverage out of pocket. This requirement is part of the Affordable Care Act (also known as Obamacare), and was upheld by the Supreme Court. The individual mandate will considerably increase the number of paying customers nationwide and should more than offset the reductions in Medicare payments to hospitals and other providers (as seen in the chart below).
Figure 1: Expansion of Coverage vs. Reduction in Payments (Hospitals)
The Future of Medicare Beyond 2022
While the above analysis suggests that the $716 billion should be an achievable savings target through 2022 given the boost from the individual mandate, what happens beyond 2022 is less clear. The spread between the benefit and the cost will continue to narrow and it is unreasonable to hope for large productivity gains that may never materialize.
If Medicare is to be sustained for future generations, citizens and lawmakers will have to find a more sustainable solution to the country’s high per capita spending on health care and high health care cost inflation. This is where the real question lies, and the potential solutions are extremely controversial.